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					Building Blocks 2004

Carol Wayman

Introduction

Coastal Enterprises Inc. (CEI) and Bethel New Life were two of 66 organizations awarded $2.5

billion from the first round of New Markets Tax Credits (NMTC) in the Spring of 2003. i Ron

Phillips, President of CEI and Mary Nelson, President of Bethel New Life were part of the

original advocacy group that met with Michael Barr, an official in the Department of Treasury in

the Clinton Administration in 1998. At the meeting, Barr proposed expanding a pilot national

credit program by proposing a multi-billion dollar tax credit to Congress to encourage private

sector investments to support community development financial institutions. “After we left the

meeting, “I asked Mary, he did say billions right?” said Phillips. Five years earlier, Nelson and

Phillips had each won $2 million in tax credits through the pilot program to encourage private

sector investments in nonprofit community development corporations working in low- income

area.[ii]

Over a 7 year period NMTC will provide $15 billion for community economic development

investments. For example, the NMTC will enable CEI to provide a $30 million below market

loan to a paper mill in Northern Maine. This loan from CEI, a community development financial

institution (CDFI) and community development corporation (CDC), will help sustain the mill’s

operations, preserving 400 jobs for its forestry-dependent community. The NMTC will allow

Bethel New Life, a faith-based CDC, to provide equity investments to its franchise tenants to

help them obtain bank financing for a commercial retail development in the Garfield

neighborhood in West Chicago.




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What is NMTC and how does it work?

The NMTC is a federal tax credit designed to encourage investors to provide long-term

capital to community economic development activities in distressed areas. The NMTC

provides $15 billion of eligible investment credits over seven years to certified

community development entities (CDEs), which "trade" those credits for equity from

private investors. In return for acquiring an ownership investment in the CDE or an

eligible community development activity , the investor is allocated tax credits over a

seven- year period equal to 5 percent of his/her equity investment for each of the first

three years and 6 percent per year thereafter. The total credits equal 39 percent of the

investment.




The NMTC is expected to be the largest new source of subsidy for community development

activities in this decade. “Traditional grant money has been increasingly harder to access; the

NMTC is a “new door of opportunity” for community development corporations and financial

institutions,” observed Anna Ginn formerly of CEI iii.



NMTC equity investments and/or loans benefit businesses by enabling them to obtain flexible

debt or capital that otherwise may not be available in the marketplace. CDEs have to invest these

funds in businesses and business developments in low- income census tracts for seven years and

then return the funds to the investors. (Figure 1) The Community Development Financial

Institutions Fund (CDFI Fund) manages most components of the NMTC: It certifies CDEs,

allocates the credits and monitors compliance with program regulations. In addition, the Internal

Revenue Service is involved in defining many of the tax requirements of the program.



                                                                                                  2
       Figure 1: NEW MARKETS TAX CREDIT- How it Works

                        CDE /
                      Tax Credit                                        Loans /
                      Application                                       Equity        Qualified
  CDFI                                                                Investments
                                                                                         Low
  Fund                   CDE /
                                                                                       Income
                       Tax Credit
                       Allocation                 CDE                                Community
                                               For-profit
                                                                                    Businesses or
                                              Community                              other CDEs
                                              Developmen
                                                   t                      Loan /
                      Tax Credits /             Entity                    Equity
                      ROI / Equity                                       Payments
                      Repayment

Investors
                         Equity
   s                      $$$




What are the different ways to use NMTC?

As of March 8, 2004, 29 organizations that had been allocated NMTC reported that they have

issued qualified equity investments (QEIs) from investors for a total of $473 million, according

to testimony before the House Appropriations Subcommittee by Wayne Abernathy, Treasury

Department Assistant Secretary for Financial Institutions.



Local groups in rural and urban areas, national organizations, and for-profit firms recognize that

NMTC can spur community reinvestment in diverse and significant ways. Kentucky Highlands

Investment Corporation (KHIC), a CDC and CDFI in Eastern Kentucky, will use its $2 million

allocation to expand the reach of its New Markets Venture Capital Fund to five states. As a

certified CDE, KHIC will encourage individual and institutional investors to buy stock or equity



                                                                                                     3
interests. Using these tax- favored equity investments, KHIC will re- invest the funds in the form

of loans or direct equity investments in “qualified active low- income community businesses” or

“qualified active low- income community activities.”iv KHIC also plans to provide financial

counseling using the NMTC. CEI’s plans to provide loans and equity investments to businesses,

details are provided in Case 1.



Urban groups have prioritized real estate development, including commercial real estate, mixed

use housing/retail buildings, or developing and selling homes for sale to individuals. Bethel New

Life is using its $4 million NMTC allocation for several projects in Chicago. “We are focused on

place-based strategies,” says President Mary Nelson. Besides providing equity investments for

its franchise tenants, this faith-based CDC is also making a million-dollar investment in the Lake

Pulaski Commercial Center building. The Columbus Association for the Performing Arts plans

to use its $6 million NMTC allocation to expand its strategy that links theater renovation and

residential housing development, to other cities. v



A 60,000 square foot mixed- use project on the waterfront in Tacoma, Washington was financed

with the NMTC. The Local Initiative Support Corporation used $10,8 million in NMTC debt to

close the Albers Mill project. Using a senior debt model, LISC lowered rates on senior mortgage

loans by 150 to 250 bases points or more below conventional sources to turn the historic flour

mill into a residential rental and commercial facility.



The City of Phoenix, Arizona won the largest NMTC award. Its CDE is led by a five- member

board of directors including representatives from Chicanos por la Causa, The Urban League, and




                                                                                                  4
the Phoenix Community Alliance. The CDE is dividing its $170 million allocation into three

funds including $20 million for small business investment fund, $120 million for business

development and revitalization loan fund, and $30 million to a venture capital fund. Possible

projects include the development of homes for sale, shopping centers, manufacturing firms, and

small business expansion.



National organizations plan to make community economic development investments through

nonprofits in a variety of states. Seedco, a national nonprofit organization plans to use its $10

million NMTC allocation to support small business incubators and other businesses in seven

states Alabama, Florida, Louisiana, Michigan, New York, Tennessee, and Texas. The National

Trust for Historic Preservation will also focus on real estate in historic areas. Its activities are

outlined in Case 2.



Community based-development organizations can also access NMTC through national banks

such as Key Bank. Key Bank’s subsidiary, Key Community Development Corporation (KCDC)

plans to use its $150 million primarily for small business loans in 12 primarily “rust belt” states.vi

KCDC will also invest in real estate, mezzanine business loans, and a brownfields

redevelopment revolving loan fund. JP Morgan Chase Community Development Group plans to

provide debt, equity, or both in leveraged deals for commercial revitalization projects, loans, and

small businesses.



Case 1: In rural Maine, CEI’s $65 million allocation will help it deliver a variety of community

development finance programs. A major feature of CEI’s program is partnership with other




                                                                                                       5
CDFIs in Maine, Northern New England and upstate New York. With a total of $110 million

under management, CEI will be able to provide a continuum of capital from micro-loans to

venture capital for a range of businesses, as well as support for affordable and special needs

housing. CEI manages a pool of bank funds for affordable housing and manages Low Income

Housing Tax Credit developments. Over the years, CEI has received funding from public and

private sources, such as the Office of Community Services, Rural Businesses Enterprise Grants,

Small Business Administration, Ford Foundation and others.



Despite CEI’s success in attracting a broad spectrum of capital providers, it has had difficulty in

attracting traditional sources of investment capital in its service area. “We hope the NMTC

award will be a useful tool to create access to new sources of capital for important projects in

low-income rural communities in Maine, Vermont, New Hampshire, and upstate New York,”

explained Phillips.



In its initial NMTC application, CEI identified a variety of project types and specific deals,

consistent with its mission, history and expertise. “We looked for solid opportunities with a

direct tie to low income communities in need of additional capital,” said Ellen Golden, senior

vice president for development. An example is a planned $30 million loan to a timberlands

company whose forests are integral to the successful resurrection of two vitally important paper

mills in north central Maine. This investment will retain 400 jobs and help the mill adapt to a

global economy, by ensuring the timberlands are retained for industrial use while being

managed on a sustainable yield basis with a limited cut and ecologically-sensitive forestry




                                                                                                   6
practices under a conservation easement. To reach these objectives CEI is working with a new

publicly-traded Canadian company vii and The Nature Conservancy.



“We hope that the NMTC provides us a chance to expand its investors’ base so it can make

additional investments in other programs areas,” said Steve Weems, manager of CEI’s NMTC

program. “Over the years, CEI has developed a strong working relationship with banks and

other financial institutions operating in its service area, but another attractive tool to mobilize

additional capital will make it possible to do “hard” projects,” he added. CEI staff spends time

with bankers to help them understand they can get Community Reinvestment Act credit from the

deals and it can help them with their traditional loan products also.



CEI will be compensated for its NMTC program activities via fee income, at one or more of three

stages of an individual transaction: up-front, during the term of the deal, and at the back-end. In

the aggregate CEI plans to cover its full program costs plus generate funds for mission-related

program initiatives, such as business counseling services. Many of these programs help the

same investors [banks] who will be providing the majority of the capital for NMTC deals.



Case 2: The National Trust Community Investment Corporation (NTCIC), the for-profit

subsidiary CDE of the National Trust for Historic Preservation (the Trust), received a $127

million allocation of NMTC in 2003. This award, the sixth-largest in the country, significantly

expands the Trust’s resources for revitalizing older and historic commercial districts nationwide.

For more than fifty years, the Trust, a private non-profit organization, has worked for the

preservation of America’s historic resources.




                                                                                                      7
Richard Moe, president of the National Trust, said, "The New Market Tax Credits will enhance

our ability to become more deeply committed and involved in low income communities where so

many of our historic resources are located. By investing in the Main Streets and historic

neighborhoods that are at the heart of our cities, we can bring new vitality to those communities

that historically have had poor access to capital."




John Leith-Tetrault, director of Community Partners, added, “An estimated 38 percent of

national historic districts in census tracts having a poverty rate of 20 percent or more so much of

the Trust’s preservation efforts are closely tied to revitalizing low-income communities that are

rich in historic resources but poor in capital.”



Two of the four NTCIC lines of business address the opportunity to combine the federal and state

historic rehabilitation credit (RTC) with the NMTC. The Historic Tax Credit Fund makes direct

investments in historic rehabilitation projects that qualify for new markets enhancement while

the Historic New Markets Conduit Fund enables tax credit investors/syndicators who do not

possess an allocation to earn the NTMC on their RTC investment. Under this “twinned” tax

credit approach, investors will be able to achieve a higher rate of return and commit more equity

per transaction.



Two projects that have benefited from NTCIC twinning the two credits are the Arthur Flemming

Center in Washington, DC and Dia:Beacon in Beacon, New York. These historic rehabilitation

projects will receive a combined $1 million in NMTC equity from NTCIC’s Banc of America


                                                                                                    8
Historic Tax Credit Fund. Emmaus Services for the Aging recently completed a $3 million

rehabilitation of three vacant residential townhouses in the Shaw neighborhood, the District’s

most historically significant African-American community and also one of its neediest. The

Arthur S. Flemming Center, as it is now known, serves as the headquarters for Emmaus’ senior

citizen assistance programs, allowing the organization closer proximity to the population it is

most trying to help. For example, the Center offers computer, art, language, movement and

music classes for the elderly as well as a communal space for them to congregate. A host of

other public welfare non-profit organizations rent office space from Emmaus at below-market

rates, making this historic 9th Street address an important resource for citizens in need and those

working to help them.



The Dia Art Foundation utilized a combined $5.4 million in historic tax credit and new markets

tax credit equity to help transform an abandoned factory into a breathtaking contemporary art

museum in the struggling riverside city of Beacon, New York. “Following a $30 million

rehabilitation, this 292,000 square foot former Nabisco printing factory has become a stunning

showroom for the Manhattan-based foundation’s world-class contemporary art collection,”

explained Leith-Tetrault. He added, “The industrial steel, concrete and glass structure—a “one-

of-a-kind” in Beacon—is the perfect environment in which to exhibit the huge sculptures and

multi-panel paintings by masters such as Andy Warhol, James Beuys and Donald Judd.” No

longer a symbol of Beacon’s stagnant economy, this property is expected to draw thousands of

tourists each year, and stands as a source of hope for continued economic recovery of the

Hudson River Valley




                                                                                                  9
The NMTC can be used to support housing development in mixed-use residential/retail projects

and the development of homes for sale. Fannie Mae has announced plans to invest in single-

family housing and mixed-use projects. To qualify, the mixed-use property must derive no more

than 80 percent of its gross rental income from the rental of dwelling units. viii For depreciation

purposes, the whole building would be depreciated as a nonresidential property. The credit

would apply to the whole mixed-use deal, not just the commercial component.



The NMTC also may be used in single-family homeownership developments through bridge

financing, although this could be tricky. Any tax credit allocation must have at least 85 percent

("substantially all") invested during the seven-year life of the credit. Thus, a CDE must invest in

-- or operate -- a housing business with substantial long-term housing flow to ensure compliance.

The CDE can make loans to or equity investments in a company that builds and/or develops

single- family homes for sale. The company must meet the criteria for a qualified active low-

income community business. A CDE could provide pre-construction bridge loans to builders

and developers with two, three, or four-year paybacks, which must be reinvested in qualified

investments within a twelve- month period to avoid recapture of the tax credits.



Under the NMTC program rules, there are a number of specific exclusions to the definition of

“qualified business,” including golf courses, massage parlors, liquor stores, collectibles, etc.

Residential rental property does not qualify, nor do single- family residential mortgages. The

NMTC cannot be used with the Low-Income Housing Tax Credit.



NMTC, the initial years




                                                                                                      10
Groups have participated in the program in a variety of ways. More than 1,362 CDEs took the

first step and received their certification from the CDFI Fund. ix Of those, 345 applied for the

credit in the first round and requested $24.5 billion in funding (nearly ten times what was

available), and 66 organizations received awards. First round NMTC allocations were

announced in March 2003 with awards ranging from $500,000 to $170 million. In that pool

nonprofit parent CDEs won 41.7 percent of the total allocation. x CDEs with a for profit parent

such as Wachovia Community Development LLC and CFBanc Corporation, received 44.6

percent of all allocations. xi



In the second round, the Fund received 271 applications for awards of $3.5 billion. The CDFI

Fund combined its 2003 and 2004 allocations ($1.5 billion and $2 billion) to make $3.5 billion

available in 2004. The Notice of Allocation Availability was announced on July 18, 2003 in the

Federal Register. Applications were due September 30, 2003. The annual NMTC allocation

amount will increase to $3.5 billion for the year of 2007.



CDEs who won allocations are finalizing their allocation agreements with the CDFI Fund and

investing in community development businesses and activities. The CDFI Fund tracks the

activities of the awardees on its community investment impact system (CIIS). All awardees are

required to use this system to report their compliance with the Fund. So far, it appears for the

fear of the recapture requirements, the majority of the credits will be invested in construction

projects instead of more difficult to monitor lending and equity investments.




                                                                                                   11
Who can access NMTC?



Only CDEs can receive a NMTC allocation. Community development organizations have several

options to access the NMTC. They can:



1) become certified CDEs and apply for tax credits directly. KHIC’s Vice President and Chief

Financial Officer, Brenda McDaniel said, “We had already received commitments of $5 million

from our investors so we knew we would have a pretty strong application.”



2) become certified CDEs and receive investments from CDEs with credits. Arlen Kangas,

president of Midwest Minnesota CDC chose this approach: “Since the program is in its

inaugural year, we wanted to know more about the process and the program before taking the

risk to market to investors and comply with all the regulations.”



3) promote financing opportunities to CDEs with allocations. CDCs are promoting their

development projects or loan portfolios to investment entities. AceNET Ventures in Athens,

Ohio is relatively new to working with the CDFI Fund. It received its CDFI designation in 2000

and has $1 million available for lending. “We do not have existing bank relationships,”

explained Director Rick Krieger, “So we are looking to go with other organizations collectively

to access credits perhaps as part of a “fund of funds” group or partnership.

The NMTC program requires that organizations wanting to participate in the NMTC Program

first apply to the CDFI Fund for CDE designation. To become a CDE, an entity must be a duly-




                                                                                              12
organized legal body and meet both a primary mission test and an accountability test. See

definitions below for more information



While government-controlled entities, nonprofit and for-profit organizations can be CDEs, only

for-profit CDEs can receive an allocation directly from the CDFI Fund. Similarly, only for-

profit CDEs are eligible to issue qualified equity investments to investors. Nonprofits can

receive investments from for-profit CDEs or assign the tax credit allocation to a for-profit entity

that the nonprofit CDE controls.



CDCs with successful track records in community development financing and the ability to

complete a strong application, manage a complex multi- year commitment and recruit investors

are more likely to consider becoming a CDE and applying for credits directly. Those CDCs with

a strong track record but no real interest in complying with a long-term federal commitment may

apply to the CDFI Fund to become CDEs and ask other CDEs with allocations that serve their

state to invest in specific projects or to invest in their CDE. Even if a CDC does not have CDE

certification, it can promote projects to CDEs with allocations.




Limited Partnerships (LP) and Limited Liability Companies (LLC) a re types of ownership of for-

profit entities.   They are also the recommended corporate form of CDE ownership for

participation in the NMTC program. xii A for-profit (i.e. taxable) CDE is necessary under the

NMTC Program in order to pass tax credits through to investors. Additionally, a for-profit LP or

LLC provides its owners with a degree of liability protection and the ability to allocate cash flow




                                                                                                 13
benefits in a sharing ratio different from the tax benefits. A subsidiary CDE does not have to be

formed at the time an application is submitted to the CDFI Fund.


CDEs must carefully budget their administrative and management costs when using the NMTC.

The NMTC program allows a safe harbor amount of up to 15 percent of the invested capital to be

retained by the CDE to cover administrative and overhead costs. This is in addition to an amount

up to 5 percent of the invested capital that can be utilized to fund a loan loss reserve. Since these

are not grant funds, any investor capital that the CDE uses for administrative and overhead costs

and/or to cover losses will have to be reimbursed to the investor at the end of the investment

period (unless the agreement negotiated with the investor provides otherwise).



The application process is expensive: groups reported it cost between $30,000 and $100,000 to

prepare an application. The application is extensive requiring extensive data on target areas,

proposed uses of credits, and long-term evaluation criteria. No federal funding is available to

reimburse CDEs for preparing proposals.



The Application Process



The CDFI Fund will accept applications for CDE certification at any time. However, an entity

interested in applying for a NMTC allocation must submit a CDE Certification Application

before the NMTC application deadline. An applicant CDE cannot jointly submit its certification

and allocation applications. The certification deadline probably will be four to five weeks in

advance of the annual allocation application deadline. The CDFI Fund strongly encourages

electronic applications.



                                                                                                   14
The NMTC legislation gives priority to CDEs with a proven track record in community

development. (Experience of either the CDE or its parent organization is considered.) The

CDFI Fund gives five priority points to investments not owned by the applicant CDE, although

CDE-owned enterprises are eligible. xiii


In the 2002 NMTC application, the possible score totaled 110 points, including 25 points each

for business strategy, capitalization strategy, management capacity and community impact. In

addition there are five priority points each for having a track record in serving disadvantaged

communities and investing in unrelated entities. Each of the 345 first round applicants were

scored by three reviewers, producing a maximum aggregate sco re of 300 points, plus 30 priority

points. An applicant had to score at least 48 points in each of the four key categories and receive

an overall score of 216 points to advance to the next round.



Successful applicants had strong comprehensive investment plans that included the following

elements:



   •   Minimum five-year strategy of investing the NMTC proceeds, including having investors

committed ahead of time

   •   Demonstrated financial and operational capacity

   •   Qualified management team

   •   Analysis of target market

   •   A plan for raising operating and investment capital




                                                                                                  15
Investor expectations and CDE management



“Winning the credits is only the first step,” cautions Roy O. Priest who formerly administered

the CDC Tax Credit and is now president of the Natio nal Congress for Community Economic

Development. “The credits give you a license to fish.”



The NMTC has been heavily promoted by accountants and lawyers so financial institutions and

leading corporate firms are well aware of it. For example, Bear Stearns, a well-known

investment firm, partnered with many CDEs to provide the investment financing in their NMTC

applications. However, potential investors may have some concerns about a new program with

new acronyms and operational standards. xiv



CEI’s Ginn explained, “We have had banks and credit union loan officers balk at participation

with the NMTC. They are evaluated on how many loans they close annually. Since NMTC is an

equity investment, not a loan, it is important to talk to a “higher up” in the bank that can make

decisions on equity investments.” She adds, “The tax credit can be used by the bank for CRA

equity credits.”



Investors participating in the NMTC Program will expect CDEs to have a successful track record

in business investments. CDEs will need to have :



* A strong investment plan that includes strict underwriting, investment monitoring and

reporting policies and procedures.




                                                                                                    16
* A board of directors or advisory board that includes members with experience in community

development and business investment, as well as residents or representatives of the low-income

community to be served.

* An ongoing asset management program to provide investors further protection from risks

related to the economic performance of the CDE’s investments and tax c redit recapture.



Investors in the NMTC receive two benefits: the tax credit and any income derived from the

investment. . xv A CDE can distribute profits, capital gains, interest and other profits at any time

during the investment period. In promoting a particular incentive, the CDE must use after tax

return when comparing a NMTC to other investments. Investor expectations for return-on-

investment (ROI) will vary based on the type of investor, maturity and investment risk. For

example, socially motivated investors generally will accept a lower ROI. In addition to the five

or six percent tax credit, investors in equity funds might receive 6 or 8 percent return, while loan

funds or real estate transactions may only earn an additional 3 or 4 percent return. See

contribution chart for an example of investor return.




                                                                                                   17
                PROJECTED VALUE OF INVESTOR EQUITY INVESTMENT
                            IN A S HOPPING CENTER
                               TAXABLE                TAX                                                          ANNUAL         CUMULATI
           EQUITY              INCOME              S AVINGS          NEW MARKETS          PRIORITY CAS H          INVES TOR        INVES TO
YEAR     INVES TMENT            <LOSS>           <EXPENS ES >         TAX C REDIT         DIS TRIBUTIONS           BEN EFIT         BEN EFIT



 1                                $0                   $0                $50,000                 $0                $50,000          $50,000
        $1,000,000
 2           -               <135,000>             54,000                50,000                70,000              174,000          224,000
 3           -               <236,000>             94,400                50,000                70,000              214,400          438,400
 4           -               <167,000>             66,800                60,000                70,000              196,800          635,200
 5           -               <112,000>             44,800                60,000                70,000              174,800          810,000
 6           -               <70,000>              28,000                60,000                70,000              158,000          968,000
 7           -               <63,000>              25,200                60,000                70,000              155,200         1,123,20
 8           -               1,793,000            <717,200>                 0                1,200,000             482,800         1,606,00

       Assumptions:
           1.    Shopping Center placed in service in the first month of year two.
           2.    Tax savings expense assumes effective tax rate of 40 percent blending federal & state tax rate.
           3.    Cash distributions at a 7 percent priority return beginning in year two.
           4.    In year eight assume refinance and a return of capital plus $200,000 and taxable inco me at an effective rate
                 of 40 percent.
           5.    In year eight assume refinance at a 9 percent cap rate and interest rate of 6 percent and 80 percent loan -to-
                 value (assumes 3 percent appreciation factor).
           6.    Investors cumulat ive net investment in year eight upon exiting LLC results in a 13.15 percent internal rate
                 of return
            7.   Equity investment is made Ju ly 1st of year one
            8.   Personal and real property depreciation exceeds cash flow to create a “loss” in years 2-7 of the investment
       period.




                                                                                                                           18
Some examples of how investor expectations vary from investment to investment. Debt

financing provides regular monthly payments while equity investments realize a percentage of

any profits. Thus, equity investments are riskier since the investor only makes money if the

business earns a profit. Start-up businesses will be perceived as higher risk investments and

therefore generally will require a higher ROI. A CDE’s unsecured equity investment in a

business will be deemed a higher risk investment than a secured loan investment so investors

will require a higher return

Investors tend to prefer tax credits to tax deductions. Tax deductions enable people to write off a

portion of their investment consistent with their tax bracket; investors who contribute to tax

credits receive a direct dollar-for-dollar deduction in their federal tax liability. Only investors

who pay federal taxes would benefit from the credit. xvi This excludes institutions that do not pay

taxes, such as foundations and universities, and corporations that do not earn profits in a given

year. It is also possible to leverage the credit. For example, a corporation could receive the

credit and a foundation receive the income stream from the same NMTC project.



Recapture is a serious concern for investors, which CDEs will need to mitigate. If recapture

occurs, all tax credits claimed by the investor before the date of recapture and non-deductible

interest must be repaid to the Treasury. Fortunately, recapture events are due to lack of

compliance with the program rules, not with the success or failure of any business. Failing

businesses that received investments or foreclosing on a loan are not recapture events if the CDE

quickly reinvests the proceeds in another qualified investment. Events triggering recapture

include a CDE falling out of certification, investing in non-qualified investments or redeeming

the investor’s capital earlier than seven years. The investors can get their money returned sooner




                                                                                                      19
than seven years if they sell their investment to a third party. If they take the money back in less

than seven years and the CDE does not reinvest it into a qualified equity investment, recapture is

triggered.



Investors, therefore, will expect a return of the capital investment and any unpaid return at the

end of the seven years or within a reasonable time thereafter. It is anticipated that investors will

expect to exit between seven and 10 years.



CDEs will want to realize a return on investment sufficient to meet the investor’s negotiated total

return expectations, including reimbursement of any investor capital used for administrative and

overhead expenses. For example, net losses sustained in the operation of a loan fund are an

element of risk that can reduce the investor’s total return. An inability to lease retail space in a

commercial building can also reduce the investor’s return.



Direct investments over time should produce returns beyond the required investor’s yield

requirements that will be retained by the CDE. These can fund operational costs or be

distributed to the CDE’s non-profit managing member or general partner (e.g., a CDC). Other

sources of funds to cover administrative expenses could include federal or state grants that

support the project including the Community Development Block Grant, Office of Community

Services CED Grants, Rural Housing and Economic Development, Economic Development

Administration Programs and CDFI Fund. xvii




                                                                                                       20
Conclusion



The NMTC provides a significant incentive to greatly expand private sector resources for a broad

range of community development activities. National and local community development

advocates are actively involved in ensuring that the NMTC benefits low- income communities

and builds the financial strength of community development institutions. Corporate investors are

already well aware of the NMTC and are likely to expect it to lower their risk and increase their

return if they invest in eligible projects. This could result in a dramatic increase in competition

for investor dollars over the next five years. xviii



Investors will expect their community development investments to be enhanced b y 5 or 6 percent

with the credits. CDCs that avoid the NMTC could lose their targeted investors to NMTC-

enhanced investments. Community development entities are encouraged to become familiar

with the NMTC to ensure the billions of dollars it provides reach their communities.




                                                                                                      21
Glossary


New Market Tax Credit Terms




Community development entity (CDE) is a designation to an organization by the Community

Development Financial Institutions Fund. CDEs must meet both a primary mission test and an

accountability test. A CDE must have a defined service area (local area, multiple local area,

state, multiple state area, or national). A CDE must have a primary mission of servicing or

providing investment capital for low- income communities. At least 60 percent of its activities

must assist low- income communities. If an entity has subsidiaries or parent companies, all must

meet the mission test. (Organizational documents such as bylaws, articles of incorporation,

annual reports, etc. can be used to show compliance). A CDE must maintain meaningful

accountability to residents of the community served by the CDE through their representation on

the governing or advisory board of the CDE or its affiliate or parent entity. At least 20 percent of

the members of the governing body must be representatives of a low- income community. If an

organization serves multiple geographic areas, it can satisfy the accountability test by

establishing appropriate local advisory boards in each area. If an entity has subsidiaries or parent

companies, all must meet the accountability test.



Collateral is property earmarked as the security or guarantee for the payment of a debt or

performance of a specific act. For mortgage loans, the collateral is the real estate property.



Debt is an amount of money owed to a lender that is repaid monthly at an agreed upon interest

rate. The funds are repaid regardless of the project’s profitability.


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Equity investments provide collateral to leverage debt financing. Equity investors earn a pre-

approved share of the profit if the company makes money. If the company does not make

money, the investor’s funds are at risk and he/her can earn less than expected or not earn

anything at all.



Look Back Period provides a CDE that received an allocation in the first round the ability to

apply the tax credit to an investment made after April 19, 2001 and before January 1, 2003. See

IRS Notice 2002-64 and 2003-56.



Low-income community is a census tract with a poverty rate of at least 20 percent or an area

median income not greater than 80 percent of the metropolitan area or statewide median. The

law also provides the option, at the discretion of the Secretary of the Treasury, for approval of a

defined low- income target area that has a demonstrated lack of capital investment within a

census tract that otherwise does not meet the overall poverty or income tests. (This authority

may be particularly useful for projects in “pockets of poverty” within higher income rural census

tracts.) A CDE can apply under a single application to serve more than one area, provided that

the areas are contiguous. Noncontiguous areas require separate applications.



Qualified Equity Investments (QEI) are the types of investments that investors can make in the

CDEs. These can be in the form of stock, partnership or membership interest and must meet

eligibility requirements.




                                                                                                  23
Qualified Low Income Community Investments (QALICI) is any capital investment (i.e.,

stock purchase in a corporation) or equity investment (i.e., ownership interest in a partnership or

LLC) in a qualified active low- income community business. QALICIs include providing loans,

equity investments, financial counseling or technical assistance to qualified active low-income

community business (QALICB) located in low- income communities; developing commercial

real estate or mixed use housing/retail buildings; developing and selling homes for sale to

individuals; purchasing loans made by other CDEs to QALICBs; and any equity investment in,

or loan to, a CDE where the proceeds are used in a manner that constitutes a qualified

investment, including capital to businesses owned in whole or part by a CDE or equity

investment in, or loan to, a CDE. xix Any loan must be a qualified low-income investment that

would be eligible under the New Market Tax Credit Program.



Qualified Active Low-Income Community Business (QALICBs) is any business executed by

an individual proprietor if the business meets the below criteria as an incorporated entity.

Likewise, any portion of a business or trade would qualify if it were separately incorporated. In

other words, a CDE can invest in a business with multiple locations if each location is treated as

a separate entity. The types of businesses are quite broad and may include commercial real

estate projects, daycare centers, retail and wholesale businesses, service providers and business

incubators. QALICBs must meet all three tests including the revenue or gross income test,

tangible property test, and the services test. The Gross-income requirement requires that at least

50 percent of a QALICBs gross income is derived from conducting a qualified business within a

low- income community. Alternatively, this test also is deemed to be satisfied if a 50 percent

standard is met in lieu of 40 percent in either the use of tangible property test or the services




                                                                                                    24
performed test below. The tangible property test requires at least 40 percent of the use of the

tangible personal property of the entity is within a low- income community. The services

performed test requires that at least 40 percent of the services performed by the entity’s

employees are performed in a low- income community.



Recapture is when an investor must return all credits received with interest to the Treasury

Department. Recapture is triggered when a CDE loses its CDE certification, misuses the quality

equity investment or the CDE redeems the QEI before the end of the term and fails to reinvest it

in a QEI.



Substantially all is the requirement by the CDFI Fund that at least 85 percent of the NMTC
allocation be invested during years 1 –6 and 75 percent in year 7. The requirement will be
considered satisfied using either the direct-tracing calculation or the safe harbor calculation,
either of which must be calculated every six months.

i
   The NMTC is part of the Community Renewal Tax Relief Act 9 Public Law 106-554 enacted
on December 21, 2000. It is Code 45D of the Internal Revenue Code.
ii
    Steinbach, Carol. The CDC Tax Credit: An Effective Tool For Attracting Private Resources To
Community Economic Development. Brookings Institution. August 1998.
iii
    Ms. Ginn is now Senior Vice President for Development at the Local Initiatives Support
Collaborative.
iv
  The definition of a “qualified active low- income community business” is quite broad
and may include commercial real estate projects, daycare centers, retail and wholesale
businesses, service providers and business incubators.
v
   New Markets Tax Credits To Be Used to Anchor Redevelopment with Theaters in New Haven,
Chicago. Washington, D.C.: Housing and Development Reporter. August 18, 2003. Pages
528-529.
vi
    Key Bank Subsidiary Sees Huge Demand for NMTC Investments, Plans Second Round
Application. Washington, D.C.: Housing and Development Reporter. August 18, 2003. Pages
527-528.
vii
     Brascan Corporation.
viii
     See Internal Revenue Code Section 168e2. While the NMTC legislation or regulations do not
cite this section, they do reference the empowerment zone statute at Section 1397C(d). This



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section describes rental real property that is not classified as residential rental property under
IRC Section 168(e)(2).
ix
    CDFI Fund. June 2003.
x
   New Markets Tax Credit Coalition: Rapoza and Associates.
xi
     New Markets Tax Credit Coalition: Rapoza and Associates.
xii
     See NCCED’s publication Getting Ready for the New Markets Tax Credit Program: How to
Form a CDE for guidance on setting up an LLC or LP.
xiii
     The statute gives priority to unrelated entities in allocation.
xiv
     The IRS expects it will require about two hours for an investor to learn about the new law and
to prepare and file the return.
xv
    In calculating the return, the investor needs to consider capital gains taxes on the amount
earned between their basis and the sales price. In addition, the basis of the investment is reduced
by the amount of NMTCs applied against their federal tax obligations. The basis is reduced by
39 percent at the end of the seven years (assuming the credit was claimed each year).
xvi
     Investors will need to file IRS Form 8874.
xvii
      NCCED publishes The Practitioner’s Guide to Federal Resources for Community Economic
Development and The State Community Economic Development Policy Catalogue that provide
comprehensive listings of the majority of federal and state community economic development
programs.
xviii
      New Markets Tax Credit Advisors: David J. McGrady.
xix
     See IRS Notice 2003-68.

Author Biography: Carol Wayman is policy director at the National Congress for Community
Economic Development (NCCED). She is the co-author of numerous reports, including two on
the New Markets Tax Credit, Federal Practitioner's Guide to Federal Resources for Community
Economic Development, State Community Economic Development Policy Catalogue, and At
Your Fingertips: An Annotated Bibliography for CED Practitioners.




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