Primer on New Markets Tax Credits

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Golden Belt in Durham, NC used NMTCs

New Markets Tax Credits (NMTC) are mentioned in several other blog posts, but normally as part of a list of various development financing tools. This is the first in a series of posts that seek to provide detailed information on the NMTC program and process.

Background

The NMTC program was enacted by Congress as part of the Community Renewal Tax Relief Act of 2000. The goal of the program is to spur growth in low-income communities by providing tax incentives to investors who invest in certified Community Development Entities. Distressed areas eligible for NMTC projects are defined as areas with a poverty rate greater than 20%, and a median income not exceeding 80% of the area median. If you are not sure as to whether or not a particular area qualifies for NMTC’s, this map is a useful tool.

The credit is equal to 39% of the total equity investment and is paid out over a seven year period (five percent for each of the first three years, and six percent for each of the remaining four years). It is important to note that the investor’s equity investment is not usually used to immediately fund one specific development. Rather, the equity investment is pooled by the Community Development Entity, (CDE), who then allocates funds from the pool into various low-income developments within the community that it services. Thus, the investor does not bear the burden of identifying a project to fund, but instead is tasked with finding a Community Development Entity to invest in. This list has hundreds of certified CDE’s that have received tax credit allocations in the past.

Real Estate developers interested in utilizing NMTC’s to finance their projects can use the funds for all major asset types. The one major limitation is that for mixed-use multifamily projects, a maximum of 80% of the revenue can come from the multifamily units. This can make mixed-use project more difficult to complete, as it may require a higher proportion of income to come from non-residential uses. To date, more than $31 billion in direct NMTC investments have been made and have created more than 750,000 jobs. Those investments have spurred an additional $60 billion in private capital being deployed in areas exhibiting severe economic distress.

Key Stakeholders and Terms

The success of the New Markets Tax Credit program relies on several key stakeholders working together.

CDE – As mentioned above the catalyst to these projects are the Community Development Entities, (CDE’s), who receive the lump sum tax credit allocation from the federal government. The CDE must apply for the allocation by providing their specific plans for the areas in which they wish to spur investment. The CDE is obligated to deploy substantially all (typically greater than 90%) of its allocation within 12 months, or face penalties from the government. The CDE’s also earn fees on the funds they allocate (typically 1-3% of the Qualified Equity Investment), and are thus incentivized to find tax credit investors to whom they can allocate the money.

QEI – The Qualified Equity Investment is the total investment made by the tax credit investor, and entitles them to claim the tax credit. The tax credit will be equal to 39% of the QEI. For example. If an investor commits $10 million as a QEI, they will be receive $3.9 million as a credit over seven years.

QLICI – The Qualified Low Income Community Investment is the investment that the CDE makes using the QEI. Using the above example, once the CDE receives the $10 million QEI, they invest those funds in the form of loans, directly into active low-income businesses in the community they serve. Thus, the investor provides funds to spur investment, and the CDE allocates those funds into local businesses.

QALICB – The Qualified Active Low-Income Business is the final recipient of the originally invested funds. The QALICB receives the QLICI. The businesses are defined as deriving a minimum of 50% of their gross income from conducting its business in a qualified low-income community, (QLIC), having a minimum of 40% of its property located within the QLIC, and at least 40% of the services performed by the businesses employees being performed within a QLIC.

This post is meant to provide some basic building blocks to understand the functionality of the New Markets Tax Credit Program. The next post will provide a more detailed look at the process, and outline some common misconceptions. In the meantime, this is an additional overview of the program provided by the IRS.

David Summers is a graduate student in the Kenan-Flagler Business School at UNC-Chapel Hill. He is also a Community Revitalization Fellow with the Development Finance Initiative.

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