Frequently Asked Questions About New Markets Tax Credits
Find answers to commonly asked questions about the New Markets Tax Credit (NMTC) program, including how NMTCs work, who qualifies, compliance requirements, and how Smith NMTC Associates can help your project.
General NMTC Mechanics
New Markets Tax Credits benefit: (1) the developers who receive a capital injection that enables them to develop projects in distressed communities; (2) the investor who receives a 39% tax credit over 7 years; (3) the low-income community that receives taxes from the property improvement and development and construction fees; and (4) the end-user low-income residents of the community who benefit from the new affordable homes, new jobs and access to services the projects provide.
A nonprofit or for-profit entity may benefit from New Markets Tax Credits as the borrower entity who receives the net benefit or project subsidy from a NMTC transaction’s tax credit equity. NMTC borrower entities are referred to as the QALICB or Qualified Active Low-Income Community Business. Key requirements for a QALICB include that it is located in or provides services to Low-Income Communities (as defined by CDFI Fund) and must maintain its QALICB status throughout a 7-year compliance period.
NMTCs enable Community Development Entities (CDEs) to provide flexible patient financing with better rates and terms than traditional financing to QALICBs (Qualified Active Low-Income Community Business). NMTCs provide a subsidy sufficient to enable development in difficult locations that traditional financing does not. The subsidy can fill market and affordability gaps to make new and/or rehabbed homes in low-income communities affordable for low- to moderate-income buyers. NMTCs can provide critical upfront capital for pre-development, acquisition, and construction costs.
A QALICB (Qualified Active Low-Income Community Business), the borrower, may benefit from New Markets Tax Credits at the end of the 7-year compliance period by retaining the net benefit, which is the residual tax credit equity. The amount of the net benefit is determined by the price the NMTC tax credit investor pays for the tax credits and the transaction costs and fees for the closing and ongoing compliance expenses. Depending on pricing, the net benefit for a $10 million NMTC transaction would range between $1.4 million and $2 million.
New Markets Tax Credits (NMTCs) are not grants. They can be provided as either an equity investment or a loan, though they are usually provided in the form of a loan called a Qualified Low-Income Community Investment (QLICI), which combines tax credit equity and leverage financing. At the end of the 7-year compliance period, some CDEs structure the QLICI so that all or a portion of the residual tax credit equity remaining is forgiven, allowing the QALICB to retain that portion of the QLICI.
A Qualified Low-Income Community Investment (QLICI) loan amount is calculated by combining the tax credit equity provided by the NMTC investor with the leverage financing contributed by the Qualified Active Low-Income Community Business (QALICB), less any upfront Community Development Entity (CDE) fees. In a typical New Markets Tax Credit (NMTC) transaction, approximately one-third of the QLICI financing comes from tax credit equity and two-thirds comes from leverage financing. For example, a $10 million NMTC allocation may generate approximately $3 million in tax credit equity and require approximately $7 million in leverage financing from the QALICB or other funding sources.
At the end of the seven-year New Markets Tax Credit (NMTC) compliance period, the tax credit investor exits the transaction, and the Leverage Lender, which is owned by the Qualified Active Low-Income Community Business (QALICB), typically acquires the investor’s interest in the Community Development Entity (CDE) lender – which is the holder of the QLICI note. The Leverage Lender can forgive the NMTC loan, enabling the QALICB to retain the residual tax credit equity, which represents the net financial benefit of the NMTC transaction.
A nonprofit housing developer can raise the leverage funds required for a New Markets Tax Credit (NMTC) closing on a homeownership project through one or a combination of the following sources: (1) Cash on hand contributed by the Qualified Active Low-Income Community Business (QALICB). (2) Leverage or source loans provided by the Community Development Entity (CDE) or another third-party lender. (3) Bridge financing that monetizes eligible project costs incurred during the 24 months before the NMTC closing. In this structure, the NMTC investor provides a short-term bridge loan that is funded and repaid on the same day as the closing. When leverage funds include borrowed capital, the loan is typically repaid from proceeds generated by the sale of the homes during the seven-year NMTC compliance period.
Nonprofits & CDEs
New Markets Tax Credits can provide critical upfront capital for pre-development, acquisition, and construction costs. Nonprofit developers (QALICBs) receive a capital injection for their projects in the form of a NMTC-funded below-market flexible loan that covers market and affordability gaps in the development of new and/or rehabbed homes in low-income communities.
The Community Development Entity or CDE is a specialized financial intermediary certified by the U.S. Department of the Treasury’s CDFI Fund to channel private investment into low-income communities through the New Markets Tax Credit (NMTC) program. CDEs apply for NMTC allocation and, if successful, are awarded NMTCs to deploy within their designated service area. CDEs select projects to receive NMTC-funded loans (QLICIs), such as healthcare facilities, community centers, grocery stores or affordable homeownership, to create jobs and stimulate local economic growth.
Since 2003, the Community Development Financial Institutions Fund (CDFI Fund) has awarded roughly $81 billion in federal tax credits to Community Development Entities (CDEs) through a competitive application process. Private investors (individual or corporate) are awarded New Markets Tax Credits to use against their federal income tax in exchange for making equity investments in CDEs who make loans that fund nonprofit developer projects in low-income communities.
Nonprofit developers can serve as the Qualified Active Low-Income Community Business (QALICB) in a New Markets Tax Credit (NMTC) transaction. Although QALICBs may be either nonprofit or for-profit entities, nonprofit status can be advantageous when a portion of the NMTC financing is forgiven at exit, enabling the QALICB to retain the residual tax credit equity. QALICBs use NMTC financing to help fund projects that expand access to housing, jobs, healthcare, grocery stores, and other essential community and commercial services in low-income communities.
Investors & Financing
Private investors (individual or corporate) receive New Markets Tax Credits to use against their federal income tax in exchange for making equity investments in CDEs who make loans that fund nonprofit developer projects in low-income communities.
New Markets Tax Credit deals use a leveraged structure. A private investor like a corporate bank, for example, supplies equity in return for tax credits; that equity is combined with leverage funding, primarily provided by the project sponsor. This leverage funding can be sourced as conventional debt, pre-incurred costs, or other cash-on-hand sources. Once combined, the leverage funding and investor equity is invested in a Community Development Entity (CDE) that makes a below-market rate flexible loan to the developer (QALICB) who develops the project in the low-income community.
New Markets Tax Credits are highly stackable and are routinely combined with conventional debt, grants, HUD programs, foundation capital, historic tax credits, sponsor equity, and other economic development incentives to maximize project subsidy and close financing gaps. It is recommended that all NMTC transactions are structured and managed by experienced NMTC professionals, including legal counsel and tax advisors, to ensure program compatibility.
Compliance & Risk Management
The CDFI Fund publishes guidance on compliance and reporting requirements of Community Development Entities (CDEs) and Qualified Active Low-Income Community Businesses (QALICBs), the borrowers who receive NMTC-funded loans. Examples of requirements for developers (QALICBs) include: the QALICB must qualify as a QALICB during the full 7-year compliance period. QALICBs using New Markets Tax Credit funding for real estate development must spend the QLICI loan proceeds within 18 months from the date of the NMTC closing, spend documentation must be tracked, and financial statements and project impact data must be provided.
NMTC recapture risk is the risk that previously claimed New Markets Tax Credits (NMTCs) could be recaptured by the U.S. Treasury if the transaction fails to meet NMTC program requirements during the seven-year compliance period. This can occur if the QALICB, QLICI, or Community Development Entity (CDE) falls out of compliance, potentially resulting in the loss of tax credits, interest, and penalties. Smith NMTC Associates, LLC guarantees the recapture risk to the investor on behalf of the nonprofit QALICB developers, and for the CDEs that Smith NMTC manages.
NMTC recapture risk arises when an NMTC transaction fails to comply with program requirements during the seven-year compliance period. Recapture can result in the loss of tax credits, plus interest and penalties. For example, recapture risk may be triggered if the Qualified Active Low-Income Community Business (QALICB) ceases operations or no longer qualifies as a business serving a low-income community before the end of the seven-year compliance period. Recapture can also occur if the Qualified Low-Income Community Investment (QLICI) no longer meets NMTC requirements or if the Community Development Entity (CDE) fails to comply with its Allocation Agreement obligations and cannot cure the violation within the required timeframe.
The compliance period for New Markets Tax Credit deals is seven (7) years from the date of the NMTC closing. During this period, the QALICB or developer/borrower will be required to remain an active business while fulfilling all other reporting requirements as outlined in the Community Benefits Agreement and other NMTC transaction documents.
NMTC Process
The length of time it takes to close a New Markets Tax Credit transaction varies based on multiple factors but can be completed as quickly as within 4 to 6 weeks. There are many legal, financial, and community impact documents that must be prepared, reviewed, and agreed upon as part of a NMTC transaction, the timeline for which influence how quickly a NMTC transaction can close.
Nonprofit developers that have projects in need of additional subsidy and think they may be compatible with New Markets Tax Credits should connect with an experienced NMTC consultant like Smith NMTC Associates, LLC who can help promote the project to relevant Community Development Entities (CDEs) with NMTC allocation to deploy, and then structure the transaction after connecting with interested tax credit equity investors to participate in the deal.
Each Community Development Entity (CDE) has different priorities for deploying their New Markets Tax Credit allocation, which is why it can be valuable to work with an experienced NMTC consultant like Smith NMTC Associates, LLC, who can provide guidance on finding CDEs interested in a specific project. Projects must be located in Qualified Census Tracts. Outcomes that CDEs may find attractive include developing affordable homes or jobs, building/improving community service or healthcare facilities, and other projects that spur economic growth in a distressed area.
Economic Impact
New Markets Tax Credits (NMTCs) were established to incentivize private investment in economically distressed communities by providing investors with a federal tax credit. Private investors (individual or corporate) receive NMTCs to use against their federal income tax in exchange for making equity investments in Community Development Entities (CDEs) who make loans that fund projects in low-income communities that stimulate economic growth by bringing affordable homeownership, jobs, health care, groceries and community and commercial facilities and services to distressed communities that lack access to capital for community development.
The New Markets Tax Credit (NMTC) program incentivizes capital investment in community development projects that spur economic growth in underserved communities by providing investors with federal tax credits. The program helps attract capital to areas that have historically lacked investment, often characterized by vacant properties, aging infrastructure, and limited access to essential services. NMTC financing has supported projects across a wide range of sectors, including manufacturing, food, retail, housing, healthcare, technology, energy, education, and childcare.