The New Markets Tax Credit Program: The Basics
The New Markets Tax Credit, or NMTC, is one of the largest tax credit programs in the United States, having issued approximately $25 billion in tax credits over the last 15 years. The NMTC is designed to encourage investment in low-income communities through the use of Certified Development Entities, specialized financial entities which must be authorized and annually re-certified by the Community Development Financial Institutions Fund (CDFI Fund), a U.S.. government agency which promotes economic development in distressed areas througout the country.
How The New Markets Tax Credit (NMTC) Program Works
Once a Certified Development Entity is certified by the CDFI Fund, it can bid for New Markets Tax Credits, a limited amount of which are issued each year. The process is competitive, and projects will be assessed on their potential positive impact on low-income communities. If a CDE receives NMTCs, it can allocate them to investors, who receive a 39% tax credit of the equity they invest in a CDE. The tax credit is taken over a 7-year period, at a rate of 5% each year for the first three years and 6% per year for the remaining four years.
Technically, a CDE can propose an investment in any eligible low-income census tract, but in practice, the more economically distressed, the more likely the CDE is to receive NMTCs. In recent years, the CDFI fund has preferred CDEs to invest mostly in highly distressed areas, where poverty rates are upwards of 30% and area median incomes are no more than 60% of the statewide median income.
In addition, a CDE must re-invest any funds provided by investors within 12 months of receiving them. A for-profit institution, such as a bank or a group of investors, could create a CDE and invest in it, or could find outside investors. While non-profits and for-profit groups can both create CDEs, only for-profit groups can receive and issue New Markets Tax Credits.
If a Community Development Entity does not invest “substantially all” of its funds into eligible commercial real estate and businesses with 12 months, or it loses its certification from the CDFI Fund, the NTMC credits that have been issued will typically be subject to recapture. This means that investors will have to repay the full amount of any tax credits back to the federal government.
Where Do CDEs Invest NMTC Funds?
CDEs invest in “Qualified active low-income community businesses” (QALICBs), which may be for-profit or non-profit entities. CDEs can do this either by purchasing an equity stake in the business, or by issuing a loan to the business, or some combination of the two. QALICBs can use CDE funds finance real estate, equipment, or other eligible assets, though the most common project types include retail/mixed use properties, manufacturing and food processing businesses, health care firms, and office and professional services companies.
NMTCs, Multifamily Properties, and The LIHTC Program
NMTCs cannot be used with purely multifamily properties. There must be at least a 20% commercial property component; i.e. no more than 80% of the property can be residential. This is based on revenue, not square footage. NMTCs cannot be directly mixed with Low Income Housing Tax Credits (LIHTCs), but they can be used in the same project by utilizing a “condominium structure,” i.e. by legally separating the commercial and multifamily parts of a building into two distinct ownership entities. Alternatively, a “master-lease” structure may be used, in which the ownership entity leases the commercial part of the structure out to an affiliate company, who subleases it to commercial tenants. These projects, in certain cases, could be eligible for HUD multifamily financing, such as HUD 221(d)(4) or HUD 223(f) loans, which provide very low interest rates and extremely long (35-40 year), fully amortizing loan terms. However, to qualify for NMTCs, businesses must create jobs in the area, which may be somewhat difficult with multifamily properties, making it slightly harder to qualify.