What are New Markets Tax Credits?
The New Markets program is designed to encourage investments in low-income communities that traditionally have had poor access to debt and equity capital. The New Markets Tax Credit (NMTC) is a 39 percent federal credit that is earned on a Qualified Equity Investment (QEI) into a certified Community Development Entity (CDE), such as NTCIC. It is claimed over a 7-year compliance period (5 percent over the first 3 years and 6 percent over the last 4 years). The CDE must make a Qualified Low-Income Community Investment (QLICI) in the form of equity or a loan to a Qualified Active Low-Income Business (QALICB) within a 12-month period. All NMTC investments must be made to entities located in qualified low-income census tracts. Visit the Novogradac New Markets Tax Credit Resource Center to determine whether your property is located in a qualified census tract. Most commercial and mixed-use real estate development projects in these qualified census tracts can be qualified as QALICBs. (Residential projects without a commercial component do not qualify.)
How do NMTCs Work in Conjunction with the Historic Tax Credit?
The New Markets Tax Credit and the HTC are natural allies. Low-Income Communities are defined as U.S. census tracts with at least a 20 percent poverty rate or household median incomes at or below 80 percent of the area or statewide median, whichever is greater. 40 percent of all U.S. and most central business district census tracts qualify for the NMTCs. Because most older buildings are found in disinvested parts of cities and towns, and most rehab tax credit projects are located in central business districts, historically 68 percent of all HTC Part 3 approvals were granted to properties in qualified NMTC census tracts. Based on the advocacy efforts of NTCIC, the IRS issued guidance in 2002 that allows for the twinning of the HTC and NMTC.
Unlike the federal Rehabilitation Tax Credits, the annual dollar volume of New Markets Tax Credits allocated by the U.S. government is capped. That means that CDEs must compete against each other to receive an allocation of New Markets Tax Credits during each annual funding round. Once a CDE wins an allocation, it partners with investors who are attracted by the tax benefits offered by the New Markets Tax Credit. In order to claim the credit, the investor must make an equity investment in a CDE.
Example: Consider the existing investment partnership between an investor and NTCIC. NTCIC has won eight allocations totaling $413 million in New Markets investment authority since 2003. To complete an HTC/NMTC transaction, the investor provides equity to one of NTCIC’s subsidiary CDEs, which the Fund invests in a historic commercial rehabilitation project that is eligible for both credits by virtue of its location in a qualified low-income census tract and the building’s eligibility for the National Register of Historic Places. In exchange, the project transfers its historic and New Markets Tax Credits to NTCIF and ultimately, Bank of America. In addition to its usual investment return on the historic tax credit, Bank of America is also earning 39 cents (the value of the NMTC) on the dollar amount of its initial HTC equity investment. Bank of America is therefore willing to make a higher aggregate equity investment to reflect the value of both credits. This so-called “twinning” of HTC and New Markets Tax Credits on the same real estate transaction has a net effect of adding 30-35 percent more equity to the transaction. This equity boost helps offset the more difficult economics of developing historic properties in low-income communities.
More information on the NMTC program is available on the CDFI Fund website.