1 New Markets Tax Credits Revisited: Origins and Current Developments May 6, 2008 Herbert F. Stevens, Esq. Gregory N. Doran, Esq.

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New Markets Tax Credits Revisited: New Markets Tax Credits Revisited: Origins and Current DevelopmentsOrigins and Current Developments

May 6, 2008May 6, 2008

Herbert F. Stevens, Esq. Gregory N. Doran, Esq.Herbert F. Stevens, Esq. Gregory N. Doran, Esq.

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Community Development Entity

Investors

Qualified Equity InvestmentQualified Equity Investment

(“Substantially ALL”)

(“Substantially ALL”)

Qualified Low-Income Community Investment

Qualified Low-Income Community Investment

Qualified Active Low-Income Community Business

Qualified Active Low-Income Community BusinessLow-Income Community

CDFI Fund(Treasury Dept.)

NMTC

NMTC

Application

CDECDE You’re a CDECDE Certification

ApplicationCDE Certification Application

NMTCNMTC

Allocation ApplicationAllocation Application

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Program Overview

• Enacted on December 21, 2000

• Part of the Community Renewal Tax Relief Act of 2000

• Creates a tax credit for qualified equity investments (“QEIs”) in Community Development Entities (“CDEs”)

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Process Overview

Step 1: Entities apply to the Fund for CDE certificationStep 2: Entities apply to the Fund for an NMTC

allocationStep 3: The Fund competitively selects CDEs to

receive NMTC allocationsStep 4: CDEs use allocations to offer NMTCs to

investors for cashStep 5: CDEs use proceeds to make Qualified Low-

Income Community Investments (“QLICIs”)

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Amount of NMTC Investment Authority Available

2001 $ 1.0 billion2002 $ 1.5 billion2003 $ 1.5 billion2004 $ 2.0 billion2005 $ 2.0 billion2006 $ 3.5 billion2007 $ 3.5 billion2008 $ 3.5 billion

Total $ 18.5 billion (not including $1 billion GO Zone)

Unallocated investment authority may be carried over from year to year until 2014.

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Credit Amount

• Equals 39% of amount of original investment• Invest $100 and Receive $39 Tax Credit• Credit taken over a 7-year period• Credit rate:

– 5% in each of the first 3 years– 6% in each of the final 4 years

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CDEs

• Definition– Community Development Entities (CDEs) must:

• Have a primary mission of community development;• Maintain accountability to residents of low-income

communities through their representation on any governing board or advisory board;

• Be certified by the CDFI Fund• Be a domestic corporation or partnership (including

LLCs)

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Substantially All & QEIs

• Qualified Equity Investment (QEI)– Requirements:

• Investment in a CDE;• Either stock or a capital interest;• Acquired at original issue solely in exchange

for cash;• Substantially all of such cash must be used to

make Qualified Low-Income Community Investments (QLICIs); and

• CDE must designate the investment as a QEI and report it to the CDFI Fund.

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Substantially All & QEIs

• Timing of Investment

– Investment must be made in the CDE within5 years of allocation of NMTCs.

– Once the CDE receives cash from an equity investment, it has 12 months to make a qualified low-income community investment (QLICI) with the equity.

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Substantially All & QEIs

• Substantially All Test– 85% of Qualified Equity Investments (QEIs), received

by the CDE, must be invested in Qualified Active Low-Income Businesses (QALICBs) to be considered Qualified Low-Income Community Investments (QLICIs).

– Continuously invested

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QLICIs

• Qualified Low-Income Community Investment– Any capital or equity investment in, or loan to, any QALICB in a

Low-Income Community;– The purchase by a CDE (the NMTC CDE) from another CDE of

any loan that is a QLICI; – Financial counseling and other services to (e.g., advice regarding

organization and operation) to businesses located in, and residents of, low-income communities; and

– Any equity investment in, or loan to, any CDE (second CDE) by a CDE (primary CDE), to the extent the second CDE uses the proceeds in a certain manner.

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QALICBs

• Any corporation or partnership (including nonprofits) engaged in the active conduct of a qualified business that meets all 5 requirements:– Gross Income– Tangible Property– Services Performed– Collectibles– Nonqualified Financial Property

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QALICBs

• Qualified Businesses– Rental real estate

• Cannot be IRC § 168(e)(2)(A) “residential rental property” (building which derives 80% or more of gross rental income from dwelling units)

• Substantial Improvements must be located on property• No lessee can be a country club, golf course, massage

parlor, hot tub facility, suntan facility, racetrack or other gambling facility or liquor store

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QALICBs

• Qualified Businesses– Excluded businesses:

• A business which develops or holds intangibles for sale or license

• A business which operates: a country club, golf course, massage parlor, hot tub facility, suntan facility, racetrack or other gambling facility or liquor store

• Certain farming businesses

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Low-Income Communities

• Low Income Communities are census tracts where:– Poverty rate exceeds 20% or– Median income is below 80% of the greater of:

• Statewide median income or• Metropolitan area median income

– “Targeted populations”– Census tracts with less than 2,000 people that is

contiguous to a low-income community and within an empowerment zone

– High migration rural counties (use 85% instead of 80%)

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NMTC Structures

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ABC Community Development FundNon-Leveraged - Closing

NMTC Investor

ABC CDE, LLC

QALICB

ABC Sponsor

Investor Member

99.99%

QEI $10,000,000

Managing Member

0.01%

Sponsor Fees $500,000

Loan Loss Reserve $500,000

$9,000,000 Loan

Interest 5.5%

7 years

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ABC Community Development FundNon-Leveraged - Compliance Period

NMTC Investor

ABC CDE, LLC

QALICB

$3,325,000 Cash Distributions

$3,900,000 Tax Credits

Interest Payments

$3,465,000, or $495,000 per year

Operating Expenses

$140,000, or 20,000 per year

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ABC Community Development FundNon Leveraged - Termination

NMTC Investor

ABC CDE, LLC

QALICB

$9,500,000 Cash Distributions

$9,000,000 Principal Payment

Release of Loan Loss Reserves $500,000

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ABC Community Development FundLeveraged - Closing

Leverage Fund

ABC CDE, LLC

QALICB

ABC Sponsor

Investor Member

99.99%

QEI $10,000,000

Managing Member

0.01%

Sponsor Fees $500,000

Loan Loss Reserve $500,000

$7,000,000 Loan (A Loan)

Interest 6.5%

7 years

$2,000,000 Loan (B Loan)

Interest 1%

40 years

NMTC Investor Economic Lender

$3,000,000 Equity Contribution

Investor Member 99.99%

$7,000,000 Loan

Interest 6.5%

7 years

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ABC Community Development FundLeveraged - Compliance Period

Leverage Fund

ABC CDE, LLC

QALICB

NMTC Investor Economic Lender

$3,900,000

Tax Credits $3,185,000 Cash Distributions

Loan A Interest Payments

$3,185,000, or 455,000 per year

$140,000 Interest Payments (B

Loan)

$3,185,000 Interest Payments

Operating Expenses

$140,000, or 20,000 per year

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ABC Community Development FundLeveraged - Termination

Leverage Fund

ABC CDE, LLC

QALICB

ABC Sponsor

NMTC Investor Economic Lender

Release of Loan Loss Reserves $500,000

$7,000,000 Payoff of A Loan

$2,000,000 B Loan

$200,000 Cash Distribution

$7,300,000 Cash Distributions

$7,000,000 Payoff of Loan

$300,000 Cash Distribution

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Recapture

• Time period for recapture– Subject to recapture for 7 years after equity

investment is made in CDE

• Amount of recapture is equal to the sum of:– NMTCs allowed for all prior taxable years; and– Interest at the IRS underpayment rate.– This amount is referred to as the

“credit recapture amount.”

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Recapture

• Recapture is triggered if:– CDE ceases to be a qualified CDE; or– Equity investment proceeds no longer satisfy the

Substantially All requirement (i.e., less than 85% are used for QLICIs); or

– Equity investment is redeemed or cashed out by CDE.

• These events are referred to as “recapture events.”

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Require Additional Information?

To ensure compliance with IRS requirements, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Herbert F. Stevens

Gregory N. DoranNixon Peabody LLP

202-585-8266

[email protected]