New Markets Tax Credit
A shoutout to our newest sponsor, K3 Construction—formerly Kfoury Construction, founded by entrepreneur George Kfoury in 1982 and since grown to $40 million annual revenue. Recently his partners bought him out and changed the name to K3. Next month they celebrate their 25th anniversary at DC’s Studio Theatre—one of the great new buildings they've built.
For a change of pace, we offer this discussion about a technical issue we've been hearing a buzz about. Our Answer Man is Don Nimey, Senior Manager in Real Estate Consulting at the Reznick Group [a Bisnow on Business sponsor].
What's the New Markets Tax Credit?
It's a general business credit run by the Community Development Financial Institutions Fund at Treasury that's targeted to financing operating businesses and not-for-profits and real estate projects in low income communities. The credit created by the act of investment is equal to 39 percent of the original investment amount. It comes over seven years, with the first three years providing a five percent credit and the remaining four years providing a six percent credit.
What's the definition of a low income community?
A census tract with either less than 20 percent poverty or greater than 80 percent of median family income of the area. Much of the tax credit has been targeted to even more severely economically distressed census tracts, for example tracts with either poverty less than 30 percent, MFI greater than 60 percent of the area, or unemployment rates 150 percent of the national average.
How does the NMTC work?
The CDFI Fund conducts an annual national application process to allocate the NMTC among certified Community Development Entities. The allocation received by the CDE can best be thought of as an "investment authority." The 39 percent NMTC is created by the act of cash equity investment into a CDE. The NMTC Program has a number of underwriting rules to qualify businesses and regulations that affect the deal structuring. The goal of the program is to get capital to communities that have not previously been able to access capital markets and to create measurable economic impact in these communities.
What qualifies as a CDE?
Only three requirements: You must be a for-profit corporation or partnership; have a mission of serving low income communities; and maintain at least 20 percent low income community representation on your board. CDEs identify a service area which can range from as small as a neighborhood to as large as the entire nation. The CDEs are the financial intermediaries in the NMTC program.
Who can invest in a CDE?
As a general business credit the NMTC is most commonly of interest to widely held C-Corps that pay taxes and are above AMT. In additional there are Community Reinvestment Act benefits to banks and thrifts that act as investors.
What types of projects qualify for NMTC?
After the qualification according to location in a qualified census tract there are several more detailed assessments that need to occur to be sure that the business will qualify as a low income community business. Since most operating businesses and real estate projects can qualify, it's easier to speak about what types of projects do not qualify. Residential rental (less than 80 percent rental revenue), casinos, package liquor stores, massage parlors, nail salons, golf courses, race tracks, most farming enterprises, banking or lending companies, companies that develop and license intellectual property—these are examples of exclusions.
What's the range of examples of approved projects?
They include saving forestry companies, financing charter schools, building film production facilities, and restoring historic theatres. To determine if a project could qualify the first test is to get an address and use the mapping utility at the CDFI Fund website to see if the project is in a low income census tract, or increasingly important to see if it is in a severely economically distressed census tract. All of the other testing will follow from this initial assessment.
What kind of firms should consider the NMTC?
Financial intermediaries should consider creating an entity to certify as a CDE. There are fees that CDE can earn for putting together a NMTC transaction with its allocation. Business owners and real estate developers that are interested in working in low income census tracts should understand which tracts could be beneficial to obtaining a lower cost of capital or more flexible financing terms. And large C-corps, especially financial institutions that are regulated by Office of Thrift Supervision Comptroller of the Currency should be interested in making investments to earn the credit.
At what stage of development can you use NMTC?
For operating businesses and real estate projects there is a requirement that the activity be expected to produce revenue within three years of the CDE investing or lending. With real estate there is a further requirement that there must be "substantial improvements." That means that for a straight refinancing of debt, the NMTC is not applicable. NMTC financing is applicable for pre-development, new construction, rehabilitation, expansion/build out, and take-out of a construction loan.