For decades, affordable housing in New York City has followed a seemingly simple rule: To make new development more palatable, half of new affordable apartments must first be offered to people already living in the area.

The policy, put in place in 1988 by Mayor Ed Koch, was designed to benefit low-income communities.

It has since been used by politicians to push major neighborhood transformations, like the redevelopment of Greenpoint and East New York, while addressing fears of displacement. San Francisco, Minneapolis, Portland and Austin have adopted similar strategies as housing costs rose and gentrification accelerated, so local residents could remain in their neighborhoods even as new luxury buildings were built.

But New York City’s policy, known as “community preference,” has ignited a fight over whether it reinforces segregation.

A federal judge in New York is allowing a civil rights lawsuit against the city to move forward, after the city spent eight years trying to quash it. The lawsuit says that by giving preference to the current residents of each neighborhood, the city’s affordable housing system violates the Fair Housing Act and New York City Human Rights Law.

The city uses a lottery system to distribute leases for new affordable homes. Competition is fierce: In 2022, there were roughly 430 applications for each home, according to the housing department. People living in the same community district as a new development typically get priority for half of the units, even if they make up a relatively small share of applicants.

The plaintiffs say the system maintains segregation because, for instance, a Black New Yorker who lives outside of the community district surrounding the West Village, which is more than 71 percent white, and applies to live there is at a disadvantage. That same New Yorker, might also have trouble in the community district that includes Flushing, Queens, which is more than 57 percent Asian.

“Whenever you’re seeking a housing opportunity, you’re supposed to be able to compete on a level playing field without regard to race,” said Craig Gurian, the executive director of the Anti-Discrimination Center, the nonprofit organization that is representing the plaintiffs. “The city’s policy takes that away from them.”

The city declined to answer specific questions about the case, but in court filings, it has argued that the policy has helped the city become less segregated overall, because Black and Hispanic people are among the biggest recipients of new affordable homes.

It has also said that the policy helps the city address fears of displacement, a “serious and legitimate concern of elected officials (and their constituents), who are ultimately responsible for approving many actions needed to facilitate affordable housing development,” court papers said.

The outcome of the case could reshape the city’s high-stakes affordable housing lottery, which fields millions of applications every year for a scarce number of lower-cost homes subsidized by the city.

More broadly, it could force New York City to rethink its approach to development, which relies on fraught negotiations with City Council members who hold enormous sway over each project’s fate. The case is also likely to help set a standard for other high-cost cities that are crafting plans to build more housing while fighting displacement.

Thomas Silverstein, associate director for fair housing and community development projects at the Lawyers’ Committee for Civil Rights Under Law, said previous cases have found that citywide preferences violate fair housing law — when, say, an overwhelmingly white suburb gives priority to its own residents. But New York City appears to be the first to test a policy at the neighborhood level.

Despite its diversity, New York City remains highly segregated. The divisions drive inequality in wealth, schools, environmental health and more.

Rafael Espinal, a former city councilman, said a rezoning of East New York in his district in 2016 would not have been possible without a community preference for the roughly 1,200 below market-rate homes.

“The community wanted to ensure the development that was being built included them,” he said.

David Yassky, a former city councilman who represented an area including Greenpoint, said that the policy helped him convince neighbors who were opposed to a 2006 rezoning. But he added that, these days, most people accept that big developments should include some lower-cost housing.

“The community preference is not as necessary to galvanize the interest,” he said.

Mayor Eric Adams has said in the past that he would end the policy in wealthier areas. During his campaign in 2021, he said that the preferences shut New Yorkers out of “desirable” neighborhoods. The city, however, has not dropped its opposition to the lawsuit.

A spokesman for the mayor, Charles Lutvak, said Mr. Adams’s strategy to “make our city more affordable is building new housing in every corner of the city — especially in neighborhoods with access to jobs, transit and economic opportunity.”

In her April 28 ruling, Judge Laura T. Swain of U.S. District Court of the Southern District of New York rejected the plaintiffs’ move to resolve parts of the case in their favor, and instead cleared the way for a jury to decide whether the policy amounted to intentional discrimination that perpetuated segregation.

She agreed that “multiple racial demographic groups are affected” in different types of community districts.