Navigating the New Markets Tax Credit Program
The following article first appeared in the Insights section of Whittlesey’s website. It is reposted here with permission.
The New Markets Tax Credit program was designed to provide 15% to 20% in cash grant funding for real estate projects, businesses, and nonprofits that invest in distressed areas.
Every year the U.S. Treasury, through the Community Development Financial Institutions Fund, issues New Market Tax Credits to Community Development Entities who then seek to invest the credits into the most impactful projects.
Community Development Entities
There are over 200 CDEs in the country, and they submit applications on an annual basis to the CDFI for these tax credits.
It is a very competitive process, as not every CDE that applies is awarded tax credits.
On average, one of every three CDEs is awarded tax credits in any given year.
Since the process is so competitive, the CDEs have become very specific in the types of projects that they support.
The CDEs that stand out and receive tax credits will then decide how to allocate those credits to the projects they believe will have the most significant impact.
Banks will then purchase these tax credits, equal to 39% of the NMTC allocation for cash.
They will set it up as a seven-year loan that is forgiven later, but the transaction results in a cash subsidy for the project.
There are a number of qualifications for the NMTC program. To qualify for NMTC financing, your project must:
- Be located in a qualified distressed census tract.
- Have a budget of at least five million dollars (but budgets of $10 million or more are preferred).
- Provide a benefit to the low-income community.
- Have identified all other sources of financing, and all sources must abide by the NMTC program’s requirements.
If the project has all other financing set up, approvals are in place, and the project can be closed quickly, then that project stands a better chance of a tax credit allocation than a delayed project.
Some other items to consider in the application process are to align your project with the annual CDFI application and identify which CDEs fit your project’s profile.
Priority is given to projects that are in underserved areas. Additionally, if projects are in opportunity zones, they have a good track record of receiving tax credits.
Once the taxpayer is awarded the NMTC, they may claim the credit for each applicable year by completing Form 8874 and filing that form with the taxpayer’s federal income tax return.
If, at any time during the seven-year period of the credit, there is a recapture event with respect to the investment, then the tax imposed for the year is increased by the credit recapture amount.
A recapture event requires the recapture of credits allowed to the taxpayer who purchased the equity investment from the CDE at its original issue and to all subsequent holders of that investment.
A recapture event would occur in the following situations:
- The CDE ceases to be a CDE
- The taxpayer’s investment ceases to meet all requirements involving investments in qualified low-income community investments
- The investment is redeemed or otherwise cashed out by the CDE
The New Markets Tax Credit program presents a unique opportunity for those investing in distressed areas to acquire essential project funding.
It offers a strategic blend of competitive tax credits and impactful community development.
It is important, however, to understand the specific requirements and challenges presented by this program, including qualifying for these credits, abiding by its regulations, and considering potential recapture events.
With its complexities, the NMTC program is not without risk.
Still, its potential to significantly impact underserved communities makes it an invaluable tool for real estate developers, businesses, and nonprofits committed to creating change in distressed areas.
By leveraging this program, we can collectively foster growth, drive innovation, and enable sustainable development in communities that need it the most.
About the author: Alex Dalene is a tax supervisor based in Hartford. His expertise spans various sectors, from nonprofits to real estate entities. He has extensive experience in the intricacies of the New Markets Tax Credit program.
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