New Markets Tax Credits – A Valuable Subsidy for Real Estate Construction in Low-Income Communities

By Lee Sheller, Esq.  

DLA Piper LLP (US), Baltimore, MD

The new markets tax credit (NMTC) is a federal subsidy that can be utilized by businesses (including tax-exempt entities) with operations in low-income communities. As the economy begins to thaw and companies seek to embark on new construction projects, this subsidy may prove useful.

NMTCs were established by Congress specifically to create jobs and drive investment in low-income communities. The credit is typically utilized by a real estate developer or by a non-real estate business constructing a real estate project located in an eligible low-income community.1

Eligible low-income communities are those census tracts where the poverty rate is at least 20% or the median family income is 80% or less of statewide or metropolitan area median income.  These census tracts include many inner-city neighborhoods in major cities and many rural communities throughout the United States.

Notably, the credit is notavailable for residential rental property, which is a building where 80% or more of the gross rental income comes from dwelling units.

The process of obtaining an NMTC can be quite intricate. Furthermore, the amount of NMTC is limited and must be obtained from a qualified community development entity which has been granted the ability to allocate NMTC by the Community Development Financial Institutions Fund in the Department of the Treasury. The business developing the project (the developer) accesses the credit through a complicated structure which optimally results in an investor obtaining a 39% income tax credit from the federal government on the funds the developer invested in the project, other than money which the company borrows from traditional mortgage lenders (the developer's funding). The developer's funding will typically consist of the developer's equity and other funds such as government grants and, in the case of tax-exempt developers, charitable contributions, for which the funding source does not require a mortgage on the property.

The subsidy realized by the developer, net of the costs of the transaction, will vary based on the particular facts of the development, but is typically about 20% of the developer's funding.

Transaction costs to implement an NMTC transaction can be high. Usually, the total project cost should be at least US$15 million to make using NMTCs worthwhile. Developers who have lined up most of their financing and need to fill a gap in the financing are good candidates to use the NMTC subsidy. Furthermore, developers who can demonstrate to the qualified community development entity that their project will produce a significant number of jobs or bring another compelling advantage to the community have the best chance to be allocated an NMTC subsidy.

As developers look for ways to resume construction across the country, this federal program may be a valuable addition to the set of financial considerations.

Copyright © 2011 DLA Piper. All rights reserved.

For more information, in the Tax Management Portfolios, see Maule, 597 T.M., Tax Incentives for Economically Distressed Areas,  and in Tax Practice Series, see ¶3170, Other General Business Credits. 

1 The credit is also available to subsidize the ongoing operations of businesses and to subsidize non-real estate capital expenditures of businesses in low-income communities, but such use has been very limited since the credit was enacted at the end of 2000.