New Markets Tax Credits: The Other Federal Tax Incentive for Preservation

The New Markets Tax Credit (NMTC) is known by preservationists as a financial tool that aids in historic rehabilitation projects, often used in combination with the federal historic tax credit (HTC). What the NMTC program was originally designed to do and the background of how it became such an important vehicle for rehabilitation financing, however, is less well-known. This article will give a brief overview of the NMTC program and tell the story of how it came to be a critical component in making many rehab projects financially feasible.

Background of the NMTC

In December 2000, the Community Renewal Tax Relief Act was passed by Congress with bipartisan support, creating the New Markets Tax Credit program to encourage investment in low-income communities. The Community Development Financial Institutions (CDFI) Fund, a branch of the Department of the Treasury, administers the program and determines the rules for qualification. Specifically, the program was designed to increase flow of private sector capital to businesses and real estate projects in underserved areas by way of a tax incentive for community development lenders and capital markets. The program’s target communities have historically had poor access to the kind of capital that facilitates projects that enhance the quality of life for residents, allow businesses to offer good jobs at living wages, and create vibrant neighborhoods. These areas are defined as census tracts where the individual poverty rate is at least 20 percent, or where median family income does not exceed 80 percent of the area median income (AMI).

The NMTC Process

The process begins with community development entities (CDEs)—the investment vehicle for the credit—which must be certified by the CDFI Fund in order to apply for an allocation award. The National Trust Community Investment Corporation (NTCIC) is a CDE. There have been 10 allocation rounds since 2003, and applications for the 11th round were due in September 2013. The NMTC application process quickly became and remains competitive—between 2003 and 2012, allocation demand has been nearly seven times greater than the total allocation amount awarded. (See chart of “Distribution of NMTC allocation rounds” in Takeaway at the end of the article.) The CDFI Fund selects CDEs that promise to deliver the maximum subsidy to people and areas of deepest economic need, and applicants often commit to invest in areas that have significantly higher poverty rates and lower median family incomes than those minimally required under the program.

The application process is not for tax credits directly, but rather “allocation authority”—the authority to raise a certain amount of capital, called qualified equity investments (QEIs) from investors. Once a CDE receives an allocation award, it can secure investors to make QEIs in exchange for the credit. CDEs often include commitment letters from investors in their application materials to show that the allocation amount they are requesting can be utilized. Per program regulations, investors must be taxpaying entities and are typically banks and financial institutions, insurance companies, or other corporate entities. (See “Sources of QEI Investment Dollars” in Takeaway at the end of the article.)

The credit equals 39 percent of the QEI amount and is claimed over a seven-year period at 5 percent in each of the first three years, and 6 percent in the final four years. This allows investors to provide more capital in the form of a QEI, and lend on better terms to projects located in target communities and the businesses that occupy them, which are called qualified active low-income community businesses (QALICBs).

Twinning the NMTC and HTC

In 1990 the National Trust for Historic Preservation created the Community Partners Program to employ preservation as an economic tool to revitalize historic properties in central business districts and urban neighborhoods. Through the program, a Historic Tax Credit Fund with a bank was established to invest in projects that qualified for federal and state historic tax credits. At the time that the New Markets program was announced, John Leith-Tetrault was director of Community Partners. With his background in community development, real estate, tax credits, and preservation, he had...