The New Markets Tax Credits program, or NMTC, is a component of the Community Renewal Tax Relief Act of 2000. The goal of the program is to stimulate investment in low-income areas. Commercial real estate developers use the NMTC program to secure advantageous debt and equity terms for developments.
In plain terms, the New Market Tax Credit program awards a 39% tax credit on invested capital to investors on qualified projects.
PROGRAM STATUS: Congress extended and increased funding for the New Market Tax Credit program in the Consolidated Appropriations Act of 2021. Read more about the extension here.
It works like this
A Community Development Entity must use …
Substantially All of the proceeds from …
Qualified Equity Investments to make …
Qualified Low-Income Community Investments in …
Qualified Active Low-Income Community Businesses located in …
Low Income Communities
New Markets Tax Credit Definitions
Community development entities, or CDEs, are corporations or partnerships who serve as intermediaries for the program. Most commonly, CDEs are non-profits. They are certified to obtain tax credits, sell them to investors, and use the proceeds to invest in Low-Income Communities. To become certified, CDEs must follow a mission of “serving, or providing investment capital for, low-income communities or low-income persons.”
“Substantially All” describes the proportion of a Qualified Equity Investment that must be invested in the project. The language intends to prevent large development fees coming from qualified equity investments.
“Qualified Equity Investments” are debt or equity contributions from investors to community development entities.
A “Qualified Low-Income Community Investments” describes an investment made from the community development entity into a qualified development project, also known as a “Qualified Active Low-Income Community Business.”
A Low-Income Community is defined as any non-metropolitan U.S. community where the poverty rate is 20% or higher and/or the median family income does not exceed 80% of the statewide median family income. Metropolitan areas can also qualify as Low-Income Communities if the median family income does not exceed 80% of the state’s or metropolitan area’s median family income. Roughly 43% of identified census tracts in the U.S. qualify as Low-Income Communities.
The Community Development Financial Institutions (CDFI) Fund is the branch of the U.S. Treasury that oversees the program and allocates funds for investors. The CDFI also determines which communities are eligible to receive NMTC investments.
The Process …
The New Market Tax Credit deal process can be broken down into four basic steps:
- Become a Community Development Entity
- Submit a New Market Tax Credit Allocation Application, and receive an allocation
- Source qualified equity investments
- Invest funds into qualified projects
Step 1: Become a Community Development Entity
- Apply for Community Development Entity certification by CDFI Fund, administered by the Treasury Department
- Get the CDE certification application here
- Meet the program requirements – get approved!
Step 2: Submit New Market Tax Credit Allocation Application
- CDE must submit a NMTC Allocation Application to CDFI Fund (Treasury Department)
- Application includes business plan and description of how the subsidy will be used to invest in low income communities
- If the application is sufficient, then the CDE will receive a NMTC allocation from the CDFI Fund
- By winning an allocation, a CDE has the right to raise Qualified Equity Investments
Step 3: Source Qualified Equity Investments
- Raise Qualified Equity Investments based on the NMTC allocation awarded to the CDE
- Pro tip: An “award of $20 million” allows for a $20 million qualified equity investment, not $20 million in tax credits
- Qualified equity investments trigger the 39% New Market Tax Credit
Step 4: Invest funds into qualified projects
- A CDE must make Qualified Low-Income Community Investments
- Qualified Low-Income Investments must be in Qualified Active Low-Income Community Businesses (or commercial real estate development) …
- Which must be located in a Low-Income Community
- The CDE must use “Substantially All” (at least 85%) of the Qualified Low-Income Investment for the Qualified Active Low-Income Community Business (no big developer fees)
New Market Tax Credit Investors
Most investors in NMTC tax credits are banks and other financial institutions, but any person or entity may purchase them.
New Market Tax Credits amount to 39% of the amount invested over seven years. Specifically, investors receive an annual 5% credit during the first three years and an annual 6% credit during the final four years.
In order for investors to claim these credits, the CDE must invest at least 85% of their tax credit proceeds in Quality Low-Income Community Investments.
Most NMTC Investments Are Loans
A Quality Low-Income Community Investment can take different forms. The majority of CDEs use the money to offer low-interest loans to real estate developers and other Quality Active Low-Income Community Businesses. To earn the Quality Active Low-Income Community Business designation, real estate developers and other businesses must meet the following conditions:
- The business must earn at least 50% of its gross income in a Low-Income Community
- At least 40% of the business’s commercial property must in a Low-Income Community
- At least 40% of the business’s services must be performed in a Low-Income Community
For-profit and nonprofit businesses may qualify, provided they maintain their status as a Quality Active Low-Income Community Business for the entire loan period.
Real estate developers benefit from New Markets Tax Credits
Real estate developers benefit greatly from the program because the NMTC covers funding gaps for development projects in Low-Income Communities.
Many CDEs also have an “equity cushion” from syndicating the tax credits to third-party investors. As a result, developers who work with CDEs usually receive loans with below-market interest rates.
Other potential incentives for developers include reduced origination fees, an extension on the developer’s interest-only loan payments, and an increased loan-to-value ratio.
The future of the New Markets Tax Credits Program
The NMTC has proven very successful since it was established. As of the end of FY 2016, the program had yielded approximately $8 in private investment for every $1 of federal funding, developed nearly 180 million square feet of commercial property, and financed more than 5,000 businesses. Additionally, the NMTC created more than 1 million jobs across a wide range of industries between 2003 and 2015; the average job cost the federal government less than $20,000.
As part of the PATH Act of 2015, the NMTC program was extended for five more years. This extension was upheld in H.R. 1, the Tax Cut and Jobs Act, which President Trump signed into law in December 2017. As a result, the program should continue unimpeded until FY 2019. Given its success, it will likely be preserved for many more years to come. However, the NMTC program’s status will remain tentative until it is permanently added to the IRS Tax Code.