December 11, 2003
Tax credit program boosts low-income communities
By DANIEL C. VAUGHN
Cairncross & Hempelmann
As part of the Community Renewal Tax Relief Act of 2000, Congress enacted the New Markets Tax Credit program to facilitate private sector investment in low-income communities.
Theoretically, the program is designed to encourage private investors who may never have considered investing in low-income communities to do so, thereby attracting new sources of private capital for a variety of projects, including retail, childcare and primary healthcare centers, which in turn attracts jobs, services and additional opportunities to areas that have historically had a difficult time sustaining economic development.
Because community development entities (CDEs) may not redeem their equity interest for at least seven years, the capital stays in the community, supporting longer-term economic development. Similarly, investors are precluded from redeeming their investments in a CDE until conclusion of the seven-year period.
Qualified CDEs may include community development corporations, community development financial institutions and small business investment corporations, as well as other entities. These CDEs apply to the Treasury Department for an allocation of new market tax credits, which are competitively awarded based on a CDE's performance, accountability, and record of success providing capital and/or technical assistance to disadvantaged businesses or communities. As a practical matter, CDEs will often enter into partnerships with developers/property owners that have available real estate assets.
Once a CDE is awarded an allocation of credits, it seeks to market the tax credit certificates to private investors — similar to other tax credit programs, including low-income housing and historical tax credits. Typical private investors will include large institutional entities that customarily invest in other tax credit programs.
In exchange for their investment, private investors receive a tax credit certificate from the CDE to attach to their federal income tax forms, making them eligible to claim a tax credit equal to 5 percent of their equity investment in the CDE for each of the first three years. Private investors then get a 6 percent credit for each of the next four years. All this totals up to a 39 percent credit against the actual investment.
Funds invested by the private investors are then used by the CDE to provide loans, equity investments and other forms of credit to qualified low-income businesses, including nonprofit corporations in designated low-income communities.
Common companies that qualify for loans or equity include small technology firms, inner-city shopping centers, manufacturers, retail stores or micro-entrepreneurs. Generally, residential rental property does not qualify as an active low-income business, although mixed-use projects can be viable candidates.
To qualify as a CDE, an entity must be a domestic corporation or partnership that:
1. Has a mission of providing investment capital for low-income communities or low-income persons.
2. Maintains accountability to residents of low-income communities through serving on a governing board and/or advisory board to the entity.
3. Has been certified as a CDE by the Community Development Financial Institutions (CDFI) Fund.
Under the auspices of the NMTC program, the U.S. Treasury Department will make $15 billion available in tax credits to private investors through CDEs — allocating $1 billion in 2001 and $3.5 billion for combined years 2002-2003.
To date (2002-2003), Washington State CDEs in Bellingham, Everett, Ilwaco, Morton, Oakville, Seattle, Shelton, Shoreline and Spokane have been awarded new market tax credits under the CDFI Fund ranging from $40,000 technical assistance grants to $2 million venture capital funding. The most recent application round closed Sept. 30, 2003, and will be awarded in March 2004.
Although the New Markets Tax Credit program is complex, it offers developers, businesses and entrepreneurs working in low-income communities an opportunity to access new sources of equity and debt capital that would otherwise be unavailable. The program can also be used with other incentive programs, including historical tax credits.
As with all new tax credit programs, there will initially be fragmentation and opportunity within the industry and a sharp learning curve for many who participate in the early stages of the New Markets Tax Credit program.
Participants will break new ground in developing appropriate yields for investors and compensation for CDEs that will act as intermediaries between investors and developers/property owners. Over time, the industry will become more consolidated, yields and compensation will become better defined and transactions more standardized, akin to what has occurred with other tax credit programs.
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