New Markets Tax Credits: Understanding the Power Of The NMTC Program

The New Markets Tax (NMTC) Program was created in 2000 under the Community Renewal Tax Relief Act to attract private capital to those projects benefiting low-income communities and persons, create jobs, and encourage additional economic development.

Projects in these communities have historically had trouble finding such investment, resulting in a lack of resources to meet community needs, including projects like job training centers, community health centers, grocery stores, mixed-use commercial developments, hospitals and others. NMTC helps these projects happen.

The Program, administered by the Community Development Financial Institutions Fund (CDFI Fund), a division of the U.S. Treasury Department, attracts private investment by awarding federal income tax credits to investors in return for their equity investments in qualified projects. These credits, equal to 39% of the investment made, are a dollar-for-dollar reduction in an investor’s tax liability, and are claimed over a seven-year period.

According to the CDFI Fund, the Program has been very effective, noting that since 2003, the NMTC Program has:

  • Created or retained an estimated 275,000 jobs
  • Supported the construction of 37 million square feet of manufacturing space, 80 million square feet of office space, and 61 million square feet of retail space, and
  • Catalyzed a ripple effect spurring further investments and revitalization in low-income communities

Like many incentive programs, while the concept of the Program is relatively simple, its requirements, implementation, and legal and tax consequences are extraordinarily complex. However, by the end of this article, you’ll know the most important points about NMTCs, including:

  • The general criteria for project eligibility
  • How a project can apply for NMTCs
  • Who the players are, and what they do, in a NMTC transaction
  • The structure of a typical deal, and most importantly,
  • What all those NMTC acronyms mean…

Once you understand these points, you’ll recognize when a project might benefit from NMTCs, and you’ll be able to speak intelligently about the Program with the many, many, many professionals needed to put together a successful NMTC deal!

Let’s first take a look at what projects are eligible for the NMTC Program.

NMTC Eligibility Requirements

The short answer to what is required for project eligibility is that a project must be the right type of business in the right census tract. The more specific answer is that the project must:

Be one of the following permitted businesses:

  • Commercial real estate development
  • Mixed-use real estate development, so long as the commercial component (as opposed to any residential components) create at least 20% of the project’s gross income
  • Community facilities
  • Non-profit facilities
  • Skilled nursing and assisted living developments
  • Hotel developments, and
  • Businesses of any type, except for the following prohibited uses:

2. Not be any of the following prohibited business:

  • Golf courses
  • Country clubs
  • Casinos, race tracks or other facilities used for gambling
  • Tanning salons, hot tub facilities, or massage parlors
  • Liquor stores for off-premises consumption
  • Farming
  • Development or holding of intangibles for sale of license, and
  • 100% residential rental housing (as noted above, subject to income limitations, residential rental housing can be part of a mixed-use project)

3. Derive 50% of its total gross income from activities in a low-income or severely distressed community.

A low-income community is a U.S. census tract with either: (i) a poverty rate of at least 20% or (ii) a median income no more than 80% of the area median income. Distressed areas are census tracts that satisfy the low-income threshold, but meet additional or more stringent criteria, such as the poverty rate must exceed 30%, or the unemployment rate must exceed 1.5 times the national unemployment average.

Fortunately, given that very few people know the poverty, income or unemployment rates for the property they’d like to build on, the Department of the Treasury’s website lists a few places where maps of the U.S. census tracts, and their NMTC categories, can be found.

4. Use a substantial portion of its personal property in a low-income community.

5. Ensure that its employees perform a substantial portion of their services in the low-income community.

6. Have less than 5% of its property attributable to (i) collectibles, and (ii) non-qualified financial property.

If a project meets these requirements, it’s eligible to become a qualified active low-income community business (QALICB) and use the Program, but, importantly this doesn’t mean it is automatically able to use the Program. This is a function of how projects are approved.

We’ll take a look at that approval process, but first, one quick thought about considering if NMTC is appropriate for a project: Is the project big enough? Given the significant costs associated with putting together a NMTC deal, there is some point at which the benefits are outweighed by the costs. This threshold amount is often estimated at $5M in project costs. If a project is smaller than that, NMTCs may not be the way to go.

How are Projects Awarded NMTC Allocations?

You may be wondering, what is an “allocation?” In many other tax credit programs, the government awards a certain amount of tax credits. But in the NMTC Program, the CDFI Fund awards a NMTC “allocation.” An allocation is the maximum qualified investment a party can make in a project that can be counted toward the calculation of tax credits.

For example, if a project has been award a $10M allocation, then qualified investments in that project up to $10M may be used to calculate the credits. If $10M of qualified investment is actually made, then $3.9M in credits ($10M investment x 39% credit rate) may be claimed.

The CDFI Fund is the body that awards the allocations, and is limited to the allocation amount authorized each year by Congress. It’s worth noting that the NMTC Program is not a permanent one, and must be reauthorized by Congress each time the previous authorization expired. In 2015, the Program received an extension through 2019.

Now that you know what an allocation is, how can a project get them? The answer is it must apply to a Community Development Entity (CDE).

A CDE is for-profit or non-profit corporation, limited liability company or partnership (1) with the primary mission of serving low-income communities and persons by facilitating investment capital for projects benefiting those communities and persons, and (2) who is accountable to the residents of the low-income community it serves.

Before a CDE can participate in the Program, and be awarded allocations from the CDFI Fund, the CDFI Fund must first certify the CDE. The certification process is described on the Fund’s website. There are hundreds of certified CDEs in the U.S., and thankfully the CDFI Fund’s website maintains a searchable list of them.

Each year multiple projects apply to a CDE requesting NMTC allocations. These applications detail the project type, location, costs, suggested financing structure, and usually the proposed investors and lenders. The CDE determines which projects it believes are most likely to be viewed favorably by the CDFI Fund, and then applies to the Fund for an award of allocations for these projects.

In addition to determining if projects meet the above eligibility requirements, a CDE will consider the project’s impacts on the low-income community. The more positive the impact, the more likely a CDE will include the project in its CDFI Fund application. While determination of impact is not an exact science, CDEs will try to quantify a project’s impact by looking at some of the following:

  • Number and quality of jobs created, including construction jobs during the project’s development
  • Does the project provide needed goods or services to the low-income community
  • Does it create social benefits to low income persons, non-profit organizations, and the community
  • What is its level of community support
  • Is it an environmentally conscious development
  • Is job training provided, and other impacts

Because the allocations requested by CDEs over the life of the Program have been approximately seven times greater than the allocations the CDFI Fund had available to award, the application process is very competitive.

Should the CDE be successful in its bid, it enters into an “allocation agreement” with the CDFI Fund, spelling out the rules, regulations and restrictions the CDE must follow in exchange for receiving the allocation. A draft version of the CDFI Fund allocation agreement can be seen at the Fund’s website, though it’s meant tohe-power-of-the-nmtc-program be tailored for each allocation.

Once a CDE is awarded the allocation, it works with each project’s QALICB to finalize the structure for their NMTC deals. There are two principal kinds of structures. Let’s take a look at them.

Leveraged and Unleveraged NMTC Structures

A word of caution. At some point in any discussion of NMTC, flowcharts showing a leveraged and unleveraged structure will be broken out. And eyes will glaze over. The bad news is that, yes, the structures, their nuances and implications are complicated. The good news is that there are plenty of consultants, lawyers, accountants and bankers who understand these complexities, and will do the heavy lifting for QALICBs.

So while we’ll dig a little bit into the weeds here, it’s easiest to think of NMTC like this: Where a project has gone to traditional lenders, its own equity, and other sources, but has only been able to find about 75% of the total financing it needs, the Program can make up that “gap” by allowing an investor to provide an equity infusion that doesn’t need to be repaid. Just keep this in mind as the weeds start to grow…

There are two general NMTC deal structures, leveraged and unleveraged. In both structures, the CDE acts as a sort of financial middleman between the funding entities and the QALICB, analyzing the transaction and monitoring compliance with the Program.

Let’s start with the simpler structure, unleveraged.

Unleveraged Structure

In this structure an investor makes an equity contribution to the CDE, and takes a limited partnership interest in the CDE. This investment is called the Qualified Equity Investment (QEI). The CDE passes this investment on, less its fees and expenses (e.g., legal and accounting fees), as a Qualified Low Income Community Investment (QLICI) to the QALICB. The QLICI can be treated as either debt or equity, but in either case, the CDE must ensure that “substantially all” of the QEI is spent in the low-income area as QLICI. The QALIB then uses these funds to pay for project costs.

Once the QEI has been made to the CDE, the investor may claim the NMTC credits. As mentioned above, the credits are equal to 39% of the QEI and are claimed over a seven-year period. The investor can claim 5% in each of years 1-3 (totaling 15%), and 6% in years 4-7 (24%).

Leveraged Structure

In a leveraged transaction, a new party is introduced, a “leverage lender” (LL). The LL (typically a bank) will loan funds, which when combined with the investor’s contribution, make up the funds needed for the total project costs. Generally LLs will fund between 75-85% of the QEI, with the investor providing between 15-25%.

The primary benefit of this structure to the investor is that the funds from the LL are combined with the investor funds to determine the QEI, causing an increase in the amount of tax credits as compared to an unleveraged deal. And while the LL’s loan amount counts toward the QEI, all of the credits flow to the investor. This results in a significant increase to the lender’s return. Let’s look at an example.

Consider an unleveraged vs. a leveraged project where in both cases the investor contributes $2.5M.

In the unleveraged project, the investor’s equity contribution of $2.5M would be the QEI. With that QEI, the tax credits created would be $2.5M x 39%, or $975,000. Thus, the investor paid $2.5M to get $975,000 in credits, or $2.56 per credit.

If a leveraged structure were used, with the assumption that the investor’s $2.5M contribution was 25% of the QEI, the QEI would be $10M. The LL’s portion is then 75% of $10M, or $7.5M. The NMTCs are then equal to 39% x the QEI, or $3.9M. Under this scenario, the investor then paid $2.5M to get $3.9M in credits, or $0.64 per credit. This is a significantly better deal than the $2.56 it would have paid per credit under the unleveraged scenario.

One additional note about the price an investor will “pay” (i.e., the investment it will make in exchange for) the credits. Like with other tax credit programs, such as Low-Income Housing Tax Credits (LIHTC), because the value of tax credits claimed over seven years is less than the lump-sum equity contribution made by the investor, investors discount the credits’ value and make a smaller investment. Discounted rates vary by project, but historically have been in the range of 70-85% per dollar of NMTC benefit.

To learn more, check out our article on Low-Income Housing Tax Credits (LIHTC)

As to the structure of a leveraged transaction, with the addition of the LL, things become a little more complicated.

The investor creates and owns a single member LLC referred to as the Investment Fund, which then takes a membership interest in the CDE. The LL makes its loan, and the investor makes its equity contribution, to the Investment Fund. The combination of the loan and contribution, the QEI, is then passed to the CDE.

The CDE then sends these funds, the QLICI, in the form of debt or equity in two streams to the QALICI: (1) a senior loan to the QALICB for the funds provided by the LL (generally with the same terms as the loan between the LL and Investment Fund) (the “A Loan”), and (2) a junior, subordinated loan to the QALICB for the funds provided by the investor (the “B Loan”).

During the seven-year compliance period (lasting the same seven-year period over which the credits are claimed), the QALICB makes interest-only payments on the loans to the CDE, who then passes them up the chain to the Investment Fund, and then to the LL and investor. Following the seven-year period, the A Loan can begin amortization, be refinanced, or be fully satisfied with a balloon payment from the QALICB. The B Loan, on the other hand, is forgiven. The investor enters these deals for the tax credits, which it will have exhausted at the end of the seven-year period.

The Dreaded Flowcharts

If the above descriptions have your head spinning, let’s see if some simple(ish) diagrams help you understand the flow of funds to the QALICB, and then back to the LL and investor. We’ll take it step-by-step.

Award of NMTC Allocation to CDE

  • QALICB (after identifying an LL and investor, makes application to) ->
  • CDE (if application is successful, CDE includes project’s request for allocation CDE’s application to) ->
  • CDFI Fund (if CDE’s application is accepted, Fund awards a portion of its allocation to) ->
  • CDE (awards use of allocation, subject to approval of deal structure and terms to) ->

Funding of Project Costs – Leveraged

  • LL and investor (provide, respectively, loan and equity/debt contribution to) –>
  • Investment Fund (passes the combined funds, the QEI, to) ->
  • CDE (takes its fees and expenses from QEI and then makes two separate loans, A Loan for LL’s loan and B Loan for investor’s loan/equity infusion, the QLICI, to) ->
  • QALICB (uses QLICI to construct project in low-income community)

Income to LL and Credits to Investor – Leveraged

1. LL income for Years 1-7:

  • QALICB (sends interest-only payment on A Loan, to) ->
  • CDE (passes payments to) ->
  • Investment Fund (makes payments on its A Loan with and to) ->
  • LL

2. Investor income for Years 1-7:

a. Credits:

  • CDE (grants authority to claim NMTCs to) ->
  • Investment Fund (who passes right to its sole member, the) ->
  • Investor

b. B Loan for Years 1-7:

  • If investor’s infusion was treated as a loan, the interest rate is typically very low, and
  • QALICB (sends interest-only payment on B Loan, to) ->
  • CDE (passes payments to) ->
  • Investment Fund (makes payments on its B Loan with and to) ->
  • Investor

3. LL income for Year 8 and beyond:

  • QALICB (sends amortized A Loan payments to) ->
  • CDE (who passes payments to) ->
  • Investment Fund (who makes payment on the A Loan it has with) ->
  • LL until the A Loan is paid in full (the A Loan may be for a term longer than seven-years)

4. Investor income for Year 8:

  • QALICB (sends nominal payment to purchase B Loan, then forgiving the B Loan it now owns, to) ->
  • Investor

Funding of Project Costs and Income to Investor – Unleveraged

The flow of funds in an unleveraged deal is the same as in a leveraged transaction, except there is no LL.

Leverage Lender Benefits and Concerns

Lenders will typically enter into these transactions for a few different reasons. Primary among these is economic: they’re lending funds in exchange for lending fees. Additionally, they have the opportunity to create business relationships in areas where other banks may have been reluctant to lend. Further, subject to certain requirements, making these loans may help the bank meet its CRA requirement. CRA is the Community Reinvestment Act enacted by Congress in 1977, which encourages banks to help meet the credit needs of their communities for housing and other purposes, particularly in neighborhoods with low or moderate incomes.

Notwithstanding these benefits, lenders unfamiliar with the NMTC leveraged structure may have some hesitation about loan terms necessitated by the Program’s rules. The primary loan limitation is that the LL can’t have a direct mortgage on the project’s property.

In order to give the LL comfort with this limitation, the A loan is typically secured by a pledge of the Investment Fund’s membership interest in the CDE. This means that if the QALICB defaults on the A Loan, and the CDE forecloses the loan, the LL can cause the foreclosure proceeds to be deposited in the Investment Fund, and then repaid to the LL to make it whole.

However, because NMTC rules require that the QEI can’t be redeemed during the compliance period (or else risk recapture of the investor’s tax credits), the investor will require the LL to sign a forbearance agreement stating that the LL won’t exercise the pledge, or take action against the Investment Fund, until the compliance period is done.

While the CDE will monitor the project for compliance with the Program, the LL will still generally require quarterly and annual reports from the QALICB to ensure the project is progressing as anticipated, including such things as reports showing compliance with the Program’s terms, income and expense statements as to the project’s operation, balance sheets, and annual operating budgets.

Use With Other Programs

Sometimes the investor’s contribution and a loan from an LL are still not enough to completely fund a project. In those cases, the NMTC benefits may be combined with other incentive programs, such as Historic Preservation Credits, grants, charitable contributions if the QALICB is a non-profit, or state credits mirroring the federal NMTCs (an example of a state new market program can be seen on the Illinois General Assembly’s website.)


The NMTC Program can make underfunded projects feasible, resulting in benefits to LLs, investors, CDEs and low-income communities. However, that benefit comes at a price: the cost of legal, accounting, tax advice, and consulting fees to all the parties involved (and given that this article is for informational purposes only, and not legal advice, we highly recommend that these fees be paid to these experts if you have any specific NMTC questions). Is that benefit worth the cost to a project? Well, time to consult with those professionals and create some flowcharts with dollars signs!

Have you done a NMTC deal? Worked with a CDE? Or even just considered NMTCs? If so, or if you have any other comments, please share them in the comments section below.

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