On September 28th the Department of Treasury issued final regulations modifying the New Markets Tax Credit Program to facilitate and encourage investments in non-real estate businesses in low-income communities. To address the concern that an investment in a non-real estate business would result in a liquidity event for the community development entity prior to the expiration of the 7 year compliance period, the final regulations provide that a CDE may reinvest a qualified low-income community investment during the compliance period in a “qualifying entity” provided that such reinvestment occurs within 30 days. A “qualifying entity” is defined as a certified CDFI or an entity designed by the Secretary of the Treasury. The regulations define a non-real estate qualified active low-income community business as any business whose predominant business activity (measured by more than 50% of the business’ gross income) does not include the development, management or leasing or real estate.
CDFI Fund Encourages Deployment of NMTC proceeds to Underserved States
In its New Markets Tax Credit 2012 Application Q & A issued last week the CDFI Fund identified those states receiving fewer New Markets Tax Credit proceeds in proportion to its state population. The CDFI Fund indicated that the deployment of New Markets Tax Credit proceeds to these underserved states would be considered an innovative us of New Markets Tax Credit Allocation and favored by the CDFI Fund. Since the inception of the New Markets Tax Credit Program, “qualified low-income community investments” have been made in all 50 states, the District of Columbia, and Puerto Rico. However, the CDFI Fund has identified Puerto Rico, along with the following 10 states, as areas that have received fewer dollars of “qualified low-income community investments” in proportion to their statewide population residing in Low-Income Communities: Alabama, Arkansas, Florida, Georgia, Idaho, Kansas, Nevada, Tennessee, Texas, and West Virginia. The CDFI Fund also considers the Island Areas of the United States (American Samoa, Guam, Northern Mariana Islands, and the U. S. Virgin Islands) to have received lower levers of NMTC investment, as these four territories have not received any “qualified low-income community investments.”
CDFI Fund Issues 2012 Application Q and A
The CDFI Fund recently issued a New Markets Tax Credit 2012 Application Q and A. Contained within this document is guidance provided by the CDFI Fund as a result of two conference calls held on July 24th and July 26th 2012 for potential 2012 Round New Markets Tax Credit allocation applicants. The participants on these calls asked for additional clarification on specific questions within the application to which the New Markets Tax Credit Program team responded. Additional guidance and clarification is provided in the Q and A with respect to what the CDFI Fund considers as innovative uses of NMTCs which includes but is not limited to: investing in Unrelated CDEs that do not have a NMTC Allocation; targeting states identified by the CDFI Fund as having received fewer dollars of QLICIs; providing QLICIs in amounts of $2 million or less; revolving QLICIs to serve more QALICBs; and providing non-real estate financing such as working capital or equipment loans. The CDFI Fund also provided examples of uses of NMTCs that would not be considered innovative which include the use of the leverage structure, combining NMTCs with historic tax credits, and investments in real estate (either to real estate QALICBs or non-real estate QALICBs) in states other than the 10 states and territories identified in the Application Q&A.
Finding New Markets Tax Credit Allocation in Strange Places
With the demand for New Markets Tax Credit allocation at a historical high, available New Markets Tax Credit allocation is appearing in strange places. The downturn in the economy has hurt not only conventionally financed projects but also projects financed through government subsidized programs including the Federal New Markets Tax Credit program. Upon the foreclosure of a New Markets Tax Credit subsidized loan, the community development entity lender is obligated to redeploy the proceeds from the foreclosure in a new “qualified low-income community investment” to a new “qualified active low-income community business”. The requirement that a community development entity lender redeploy the proceeds of a previously extended New Markets Tax Credit subsidized loan presents an opportunity to sponsors to “reuse” New Markets Tax Credit allocation for a project. The new loan must satisfy the flexible lending product requirements of community development entity but may not contain a forgivable B note or a 7 year maturity.
Twinning the New Markets Tax Credit
While the Federal New Markets Tax Credit Program and the Federal Low-Income Housing Tax Credit Program are mutually exclusive – the former available for non-residential property and the latter available for residential rental property – the New Markets Tax Credit may be combined with other federal tax credits such as the Historic tax credit and the Renewable Energy tax credit. In the twinning structure – which is distinct from each tax credit being generated by a separate investment – the equity which generates the Historic or Renewable Energy tax credit is contributed as a qualified equity investment by an investor in a community development entity with an allocation of Federal New Markets Tax Credit authority. The result of twinning is to generate a New Markets Tax Credit on the Historic or Renewable Energy tax credit equity. While the pricing of a twinned credit will be more than the Historic or Renewable Energy tax credit without the New Markets Tax credit enhancement, the benefit may not always be significant when you factor in: (a) added transactional costs as a result of the complexity of the transaction; (b) the payment of the customary fees to the community development entity based on the amount of the “qualified equity investment”; and (c) the limited market of investors for the twinned credit. In a nutshell, a financial analysis of the net benefit of twinning the credits should be performed before pursuing the twinning of two federal tax credits.
New Markets Tax Credit Allocation as Inexpensive Private Equity
While the demand for New Markets Tax Credit allocation is at a historical high the Duane Morris New Markets Tax Credit practice group has been successful in assisting clients identify allocation available from community development entities in which the benefit provided to the sponsor is in the form of a subordinate interest free loan in the amount of the net tax credit equity. This subordinate loan payable in 7 years and may be converted into an equity interest in the sponsor. While this form allocation may not be desirable to non-profit sponsors, the allocation provides for-profit sponsors with what is tantamount to inexpensive private equity. Projects which have the best opportunity to receive this form of New Markets Tax Credit allocation: (a) are located in non-metropolitan census tracts; (b) create significant permanent jobs: and/or (c) are supermarkets in a food desert.
The Future of NMTC Targeted Population Transactions
In 2011 the Service released final regulations which provide how “targeted populations” may be treated as “low income communities” where projects are eligible for the New Markets Tax Credit. Similarly the CDFI Fund amended the form of its allocation agreement to elevate the “targeted populations” criteria to one of its four primary criteria. The result is that satisfaction of the “targeted population” requirements under the Code may alternatively qualify a project as located in a “low-income community” and the satisfaction of the requirements under the allocation agreement may elevate the project to “highly distressed” status. Historically “targeted population” transactions have been challenging because of the added requirements of initially qualifying individuals as “low-income individuals” and insuring that future individuals will qualify as “low-income individuals” during the 7 year tax credit compliance period. While the final Treasury regulations and the revision to the allocation agreement will encourage the use of the “targeted population” criteria, the qualification and compliance requirements of using the “targeted populations” criteria will continue to be a hurdle for both community development entities and tax credit investors for all but the most compelling projects.
New Markets Tax Credit Demand and Pricing on the Rise
The reduction of the annual allocation of New Markets Tax Credit authority by the CDFI Fund from 5 billion dollars to 3.5 billion dollars after the expiration of Stimulus legislation and the increased awareness of the benefits of the Program have created a tremendous demand on community development entities who receive an allocation. of New Markets Tax Credit authority. Sponsors seeking to identify New Market Tax Credit allocation for projects should be aware that community development entities are focused on transactions which result in substantial job creation and supermarkets in designated food deserts. The good news for sponsors is that investors are paying higher prices for New Markets Tax Credits. Accordingly, while it has become more challenging to identify allocation, the equity generated for a project through an allocation of New Markets Tax Credits should be greater than in prior years.