A successful real estate project often requires blending several sources of funding. New Market Tax Credits (NMTC) are an alternative method of financing projects located within a specific ‘Low income urban/rural community (LIC). The NMTC program was enacted as a part of the Community Renewal Tax Relief Act of 2000. Administered by the Treasury Department, the goal of the NMTC program is to stimulate job creation and encourage investment and revitalization of low income communities found in urban and rural settings. The next round of competition for funds under the NMTC Program combines calendar years 2013 and 2014 for a total tax credit allocation of $8.5 billion ($3.5 billion for 2013 and $5 billion requested in the President’s 2014 Budget , pending Congressional authorization).
The NMTC program attracts private investment to LICs by providing investors a substantial federal tax credit. Investors receive a 39% credit of the total Qualified Equity Investment (QEI) made in a Community Development Entity (CDE). As a result of the credit, the investor accepts a lower rate of return, often forgiving all or part of the debt. In turn, the Borrower/Project receives significant benefits which include lower interest rates and interest only loan payments for the first seven years. Sometimes, projects receive a capital contribution gift of 23 – 28%, along with a flexible structure that can be blended with other financing mechanisms to completely fund the project.
Here is an example of how NMTCs work.
- A leveraged lender makes a loan in the amount of $7,800,000 to a pass through entity also known as an upper tier investment fund (Investment Fund).
- An equity investor (NMTC Investor) makes a capital contribution of $2,200,000 into the Investment Fund.
- The Investment Fund provides a $10,000,000 QEI to the CDE in exchange for $3,900,000 (39% of the QEI) in tax credits for the NMTC Investor.
- The credits are taken by the NMTC Investor over a seven year period.
- The CDE then makes loans to a Qualified Active Low Income Community Business (QALICB). The benefit to the QALICB is that it will generally not have to repay the equity investment of $2,200,000. Please note that a for-profit entity may be subject to taxation on the forgiveness of indebtedness.
Thus, NMTC’s can be a financially advantageous funding mechanism for both investors and project developers.