New Market Tax Credits

New Market Tax Credits are one way that governments provide access to capital to businesses in distressed areas.  This relatively new tax incentive structure creates affordable commercial space in distressed neighborhoods by making capital more accessible to qualifying businesses and organizations in designated census tracts.  This page will address the following topics:

What are New Market Tax Credits?

New Market Tax Credits began when former Democratic President Clinton and then Republican Speaker of the House, Dennis Hastert (IL), lead a bipartisan effort to address a key problem in depressed areas: entrepreneurs have limited access to information and capital needed for local economic development. In 2000, lawmakers passed the Community Renewal Tax Relief Act (PL 106-554) and rolled out a system for New Market Tax Credits (NMTC). This NMTC system subsidizes private sector investment in these communities by providing business owners with access to patient, flexible sources of capital to businesses and projects.[1]

The driving concept behind the NMTC is that the lack of capital in new markets stymies economic growth in both urban and rural low-income communities in spite of the strong business opportunities available. The NMTC system addresses the lack of capital in low-income communities by providing tax breaks to private and non-profit entities that invest capital in “new markets.” By stimulating private investment in “new markets,” the government makes capital accessible to these communities with the focus of growing businesses, creating jobs, and sustaining healthy local economies.[2] The chart below illustrates how money ends up in the hands of qualified low-income businesses:

NewMarketTaxCredit.Example

Stakeholders

From the chart above, there are four primary Stakeholders involved with the NMTC system:

(1) The department of the treasury, which oversees and regulates the process;
(2)The community development entities (CDEs) who act as brokers for the credits,
(3) The investors who provide capital to the CDEs; and
(4) The “Qualified Low Income Businesses” (QALICBs) that are awarded the funds.

One such business is FareStart, a non-profit in Seattle that provides culinary job training and placement for the homeless and disadvantaged. With the help of tax credit financing ($17 million in New Market and Historic Tax Credits combined), FareStart was able to upgrade and expand its facilities.

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https://www.washington.edu/wholeu/wp-content/uploads/2015/06/f.jpg

The tax credits helped the business increase the number of people served and increase revenue from their food service by 80%. Refer to the stakeholder outline below for more information on the various NMTC Stakeholders:[3]

  • The Federal Government:
    The Department of Treasury allocates tax credits to local Community Development Entities (CDEs). The CDFI fund delegates its authority to allocate tax credits to a local CDE in a highly competitive process. The Treasury Department monitors the allocation process and compliance, while the IRS monitors the investors and taxpayers.
  • Community Development Entity:
    CDEs apply to the CDFI for tax credit allocation authority in an extremely competitive process. A successful CDE applicant is awarded money from investors that it in turn disburses in the form of loans and equity investments to qualified low-income community businesses (QALICBs). A CDE may elect to serve specific demographics or project types.
  • Private Investor:
    An investor in the NMTC system gets two things out of the system- a tax credit from the government, and interest on the Qualified Equity Investment (QEI) it provides to a qualified CDE. The tax credit is equal to 39 percent of the equity investment. The Credit is realized over a seven-year period, at 5 percent annually for the first three years (15%) and at 6 percent in years four through seven (24%). There is a penalty if an investor redeems a NMTC investment before the seven-year term is complete- the credits are all reclaimed by the government, with interest. Investors are taxed on any capital gains or profits generated from their investment in the NMTC system.
  • QALICBs:
    Qualified Low Income Community Businesses apply to a designated CDE in their state for tax credit financing. QALICBs benefit from this system because they get access to capital at below market interest rates, with more lenient credit standards, and a 7-year amortization period, which is longer than most traditional loans. The application process is also competitive for QALICBs – the CDEs that award the funds put a high priority on community impact.

    These businesses must be in a qualified census tract. These tracts are designated by the federal government, which looks at census data on income levels in individual census tracts. The competition between qualified businesses has driven CDEs to focus investments in particularly distressed communities where conventional financing mechanisms are lacking. In two (2) four-year periods (2003 – 2007 and 2008 – 2014), the number of NMTC projects in communities with high unemployment (over 1.5 times the national average) increased by 14 percent.[4]  To find out if you are in a Qualified Census Tract, refer to the following interactive mapping tools:

 

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Map of Eligible Census Tracts – Screenshot from: http://www.novoco.com/new_markets/resources/ct/

Developing and Leasing Commercial Space

Land Acquisition: NMTC financing can be used for acquisition costs depending on the agreement between the CDE and the QALICB. However, the tax credits are only disbursed to qualified census tracts where the individual poverty rate is at least 20 percent or where median family income does not exceed 80 percent of the area median. Activities must also be focused in the qualified census tract and consistent with the purpose for which a QLIBE received tax-exempt status.[5]

Shared Equity Model: Successful QALICB applicants will receive an Equity Loan from Investor, a Leverage Loan from Investor, and Tax Credit Equity. Many features set the New Market Tax Credit apart from other shared equity models, including:[6]

  • 7-Year Financing period: Businesses receive a longer-than-usual amortization of debt
  • Optimal project size: $10 million – $15 million.
  • Qualified Equity Investment (QEI): Determines the size of the Tax Credit Equity and leverage loan required to finance the project. Market forces dictate the value of the tax credit based on how much investors are willing to spend for tax credits.

NMTC Strengths

NMTC investments are effective at creating capital, spurring development in low-income neighborhoods, and creating jobs.[7] The following impacts were realized over a nine year period (from 2003-2012):

  • Capital: In Washington State, $1.04 Billion in NMTC investments leveraged a total of $826 million in other sources for a total of $1.9 Billion in total project investments.
  • Development: 104 Businesses in Washington received NMTC financing.
  • Employment: In Washington, New Market Tax Credits have created 11,377 construction jobs and 10,674 full-time jobs.

NMTC Weaknesses

In spite of their effectiveness, NMTC are not the panacea of affordable commercial and retail space. The New Market Tax Credit is a highly complicated and formal way for businesses to access capital, but it will only accommodate certain types of businesses investments.

  • One size does not fit all: The complicated financing mechanism does not work for all types of businesses, depending on the size and activity.
  • Supply vs. Demand: Demand for NMTC financing far exceeds availability and actual disbursement. There are limits to how much the government is willing to allocate credits during a tight budget season.
  • Affordability: Access to capital is crucial for small business owners in distressed neighborhoods, but it does not guarantee that the space will remain affordable.  A cash injection can solve a lot of problems, but it won’t address the larger systemic issues of affordability.

Multimedia Tools

NMTC Sources

[1] “NMTC Progress Report.” Economic and Political Weekly 40.18 (2005): 1796. NMTC Coalition. Web. <http://nmtccoalition.org/wp-content/uploads/NMTC-Progress-Report-2015-Final.pdf>.

[2] Usinger, Eric. “Using New Markets Tax Credits to Finance Commercial Real Estate Development.” Journal of Affordable Housing 3 & 4 20 (n.d.): 270-83. Print.

[3] Sanders, Michael I. “How Nonprofit Organizations Can Use the New Markets Tax Credit.” Blank Rome LLP, n.d. Web. 23 Nov. 2015. <https://www.blankrome.com/siteFiles/Publications/27E9C61B6D14DB754B19C370C53231B8.pdf>.

[4] “NMTC Progress Report.”

[5] “The Economic Impact of the New Market Tax Credit.” (2013): n. pag. The New Market Tax Credit. New Market Tax Credit Coalition. Web. 23 Nov. 2015. <http://nmtccoalition.org/wp-content/uploads/state-profiles/Washington.pdf>.

[6] “New Markets Tax Credit Fact Sheet.” New Markets Tax Credit Coalition, 05 June 2012. Web. 25 Nov. 2015. <http://nmtccoalition.org/fact-sheet/>.

[7] “The Economic Impact of the New Market Tax Credit.”

“FareStart Adult Culinary Academy.” $17 Million in NMTCs Combined with Historic Tax Credits. CBO Financial, Inc., n.d. Web. 03 Dec. 2015. <http://www.cbofinancial.com/success_stories/fare_start.html>.

Abravanel, Martin, Nancy Pindus, Brett Theodos, Kassie Bertumen, Rachel Brash, and Zach McDade. “New Market Tax Credit Program Evaluation.” Metropolitan Housing & Communities Policy Center (2013): n. pag. Urban Institute, Apr. 2013. Web. 9 Dec. 2015. <http://www.taxpolicycenter.org/UploadedPDF/412958-new-markets-tax-final.pdf>.