The New Markets Tax Credit (NMTC) was created by congress in 2000 to stimulate long-term investment in the economic development of low-income communities. It is a 39 percent credit (earned over seven years) for investors in commercial projects in qualifying commercial districts. The federal program is projected to generate $15 billion in new investment by 2012.
The impact that $15 billion in capital will have on the commercial landscape is clearly significant, but what are the implications for older and historic resources? Preservation advocates are proactively seeking ways to use the New Markets Tax Credit to support historic rehabilitation projects and to promote small business expansion/retention on Main Street. This article will outline the key mechanics of the credit, suggest how the reader may utilize it, and profile how the National Trust is putting the credit to work on the street.
Unlike the rehabilitation tax credit, the New Markets Tax Credit is capped and allocated through certified, private, for-profit entities called certified "Community Development Entities" (CDEs). CDEs must apply for an allocation of New Markets Tax Credits from the administering body, the CDFI (Community Development Financial Institutions) Fund of the U.S. Treasury. The first round of allocations was awarded in March 2003 and the second round is expected in the spring of 2004.
Once the CDE has received its allocation award from the CDFI Fund, it creates a legal partnership with an investor to facilitate the exchange of tax credits for the investor`s equity. Companies and individuals invest in the CDE, then the CDE, in turn, invests that equity in or loans it to businesses in qualifying districts. The investor earns a dollar-for-dollar reduction in taxes owed over a seven-year period, equal to 5 percent of the equity investment for each of the first three years and 6 percent for the remaining four, for a total of 39 percent. In this way, the tax credit serves an incentive for attracting new sources of capital to underserved communities, communities that may be poor in capital but rich in historic properties.
Here`s how it might work: Our Town Community Development Corporation becomes a certified CDE and is awarded an allocation from the federal CDFI Fund. Friendly Neighborhood Bank invests $1,000,000 in the Our Town CDE. The CDE then makes a $1,000,000 loan to Downtown Department Store to enable it to rehabilitate and expand its location on Main Street. In addition to earning a return of its principal and interest on its $1,000,000 loan, Friendly Neighborhood Bank will receive $50,000 in tax credits in 2003-2005 and $60,000 in 2006-2009, for a total of $390,000 in credits.
For an investment to earn the New Markets Tax Credit, the investment must be made in a "qualifying, active low-income community business." To meet this definition, a certain percentage of the business`s physical assets, income, and services must be tied to a low-income community (entities not typically thought of as businesses, such as nonprofit organizations and real estate limited partnerships, qualify if they meet this test). A low-income census tract is one in which 1) the poverty rate is at least 20 percent, or 2) the median family income is 80 percent or less of the statewide or metropolitan median family income, whichever is greater (statewide applies for rural areas).
Qualifying investments include those that finance start-up business costs, inventory expansion, business expansion or acquisition costs, rehabilitation of commercial space, location of small-scale industries in upper stories, and stimulation of mixed-use commercial/residential space. The New Markets Tax Credit may be coupled with the 20 percent or the 10 percent rehabilitation tax credit, but not the low-income housing tax credit.
Although the NMTC was intended primarily for business development and expansion, it is being used more frequently for real estate development. Rental residential real estate is excluded unless it is part of a mixed-use project and commercial portion generates at least 20 percent of the building`s total revenue.
The NMTC brings more investment dollars to a qualifying project. If the NMTC is earned on an equity investment (such as when an investor purchases the historic tax credits generated by a qualifying historic rehabilitation project), NMTC financing can bring 20-25 percent more equity to the project. A combined historic/New Markets investment is referred to as a "twinned" investment. This additional equity financing could reduce the size of the project`s debt, thus reducing the drain on the property`s or the business`s cash flow.
When the NMTC is earned on a loan, the lender is expected to pass along this benefit in the form of lower interest rates (1.5 to 2 percentage points). The lower interest rate may lead to increased cash flow that can be put toward other expenses such as additional reserves for the project. This helps to increase investor confidence, which may lead to approval of "marginal" deals -- those that do not fully satisfy conventional underwriting guidelines. The new capital that is attracted by the NMTC and the lower interest rates serve to increase the lending and equity investments that CDEs are able to provide to areas in economic need. This helps create jobs, increase assets, and achieve community stability. Treasury regulations also provide that some fee revenues (up to 15 percent) can be retained by the CDE to sustain its operations.
How Can Communities Participate
The process for becoming a certified CDE is not difficult, but the process of applying for an allocation is extremely timeconsuming, complex, and competitive. The CDFI Fund received applications in the first round from 347 groups requesting almost $26 billion in funding (more than 10 times the amount available). The second round, to be awarded this spring, is almost as competitive. A more sure-fire approach is to research which CDEs received allocations in your area and learn if their CDFI-approved loan and investment products match your project. [Visit the CDFI Fund website https://www.cdfifund.gov/programs-training/Programs/new-markets-tax-credit/Pages/default.aspx for links to allocatees and their profiles.] From the advocacy perspective, start by learning where the low-income census tracts are in your area and then identify which vacant commercial properties or existing businesses might be attractive opportunities for investors. Refer to the CDFI website for additional information.
The National Trust Puts the NMTC in Action
The National Trust’s CDE, the National Trust Community Investment Corporation (NTCIC), received a $127 million New Markets Tax Credit award in the first round of NMTC allocations in March 2003. The Trust views the allocation as an important tool for revitalizing older communities in culturally diverse urban and small town centers. As such, the Trust is using the allocation to engage investors in projects that feature the adaptive use of historic and older properties that are compatible in scale and design to the surrounding neighborhood and that support locally owned businesses. It does this through four new lines of business: Two of them relate to providing the NMTC to investors in rehabilitation projects that qualify for the 10 or 20 percent rehabilitation tax credits and the other two bring the NMTC to small business/real estate redevelopment in Main Street communities and other commercial districts.
The rehabilitation of the Arthur Flemming Center in Washington, D.C., demonstrates how the 20 percent historic rehabilitation tax credit and the NMTC can work with smaller, Main Street–scale projects. NTCIC provided both New Markets and 20 percent historic rehabilitation tax credit financing for the $3.1 million rehabilitation of three vacant rowhouses. The center includes recreational and educational space for neighborhood senior citizens as well as upper-floor offices for nonprofit organizations that serve the social service needs of Shaw, a predominantly African-American Main Street community.
The properties are contributing structures to the Shaw Historic District, and the rehabilitation followed the Secretary of the Interior’s Standards, making it eligible for the 20 percent rehabilitation tax credit. The National Trust’s Banc of America Historic Tax Credit Fund, a $40 million equity fund capitalized by the Bank of America and managed by NTCIC, was the purchaser of the historic and New Markets tax credits. Because of the project’s location and the nature of the business, the act of purchasing the historic tax credits was a qualifying equity investment and New Markets Tax Credits were generated by the transaction. The result was a “twinned” equity investment of approximately $500,000 in the project.
NTCIC is also working to find other opportunities for Main Street communities to benefit from the NMTC. Specifically, it has partnered with local groups in six demonstration sites to launch its Main Street business lines. They are Rock Island, Ill.; Macon, Ga.; Pittsburgh, Pa.; and the states of Iowa, Kentucky, and Washington. In each locality, the Trust is using the NMTC to attract more local dollars to the community’s older and historic resources by improving terms for business loans and loans for commercial real estate transactions.
In Pittsburgh, for example, $3.9 million of the Trust’s NTMC allocation has been committed to the Pittsburgh History and Landmarks Foundation to support the $4 million rehabilitation of a four-story industrial-tech office building in the city’s Northside area. In Lexington, Ky. -- a Main Street community -- Renaissance Kentucky has received a $5 million commitment of the Trust’s allocation for a project to adapt a former Woolworth’s Building for new use by a big box retail store. It will reduce the interest rate to 1 percent on a $5 million construction/permanent loan. These projects offer promising examples of how the New Markets Tax Credit can bring additional resources to Main Street communities which contribute such vitality and local character to the commercial landscape.
All of the Trust’s 2003 allocation has already been committed. Contingent upon access to a future allocation, the Trust plans to continue to support twinned historic/New Markets projects and businesses in Main Street commercial districts. For more information on NTCIC’s NMTC activities and the Banc of America Historic Tax Credit Fund, please visit http://ntcic.webfactional.com/tax-credit-basics/new-markets-tax-credits/ or call (202) 588-6054.
Publication Date: May/June 2004