Something 'New' In The Big World of Tax Credits
In December 2000, Congress passed, with bipartisan support, one of the most important federal subsidies for economic development in low-income and economically depressed areas in three decades. The program has been coined the New Markets Tax Credit program and was designed to encourage capital investments in areas that are distressed as a result of neglect and under-service. The focus of the program is to bring direct investments into distressed communities that otherwise would not receive such opportunities.
The NMTC is an incentive tax credit that induces investors to invest in Community Development Entities, which then invest in projects in distressed communities. The equity investments are generally referred to as Qualified Equity Investments. The projects in these communities are typically referred to as Qualified Low-Income Community Businesses and can include retail real estate developments, warehouses, grocery stores, mixed-use commercial and residential buildings.
It should be noted, however, that before planning a New Markets Tax Credit deal, investors should first ensure that the area they are targeting qualifies for the program. To do so, the investment must be located in a low-income community. Such communities are generally defined as census tracts where the poverty rate either exceeds 20 percent or the median income is below 80 percent of the greater of the statewide median income or the metropolitan median income.
Although there are various types of businesses that can benefit from the NMTC, not every type of business qualifies for the program. Prohibited business, often referred to as "sin businesses," include country clubs, golf courses, massage parlors, hot tub facilities, tanning facilities, racetracks, gambling facilities, liquor stores, businesses that develop or hold intangibles for sale or license, and certain farming businesses. If these so-called "sin businesses" are entered into, it is cause for a recapture of the tax credits.
Prospective investors should carefully consider the tax benefits they will receive from participation. The NMTC program provides investors with tax credits over a seven-year period. This includes 5 percent during the first three years and 6 percent during the last four years, which, in total, equal 39 percent of the amount invested in the NMTC project. Due to the amount of regulations with respect to this tax credit, investors must be careful to comply with all of the NMTC requirements; otherwise, they might find themselves faced with recapture of the credits.
Generally, recapture only occurs when one of three events occurs:
The Community Development Entity ceases to be viable.
Less than 85 percent of the investment is used for a Qualified Low-Income Community Investment.
The equity investment is redeemed or cashed out by the CDE.
The results of the NMTC program thus far are promising. A vast array of investors has drawn hundreds of millions of dollars in equity investments to low-income communities.
While many types of businesses can be supported by the program, it appears that the significant majority of projects taking advantage of the credit are in the real estate area (largely because the rules favor real estate transactions).
Those who are looking to invest in qualified NMTC projects should consider doing so. The program, however, is not without its complexities. Often, the leveraged structure of NMTC deals is confusing even for the most seasoned practitioners. Investors considering participation should contact their legal counsel to discuss issues of feasibility, qualification and competition for these highly sought-after tax credits.
Jennifer Nichols is an attorney in the Grand Rapids office of Warner Norcross & Judd. She focuses her practice in the areas of real estate and tax law.