New Markets Tax Credits: How the Program Works

The New Markets Tax Credit program is one of the least understood funding sources in commercial real estate. It can cover a real slice of a project’s cost, but only if the project sits in the right place and the numbers can carry the legal work. Here is how it works in plain English.

What is the New Markets Tax Credit?

The New Markets Tax Credit (NMTC) is a federal tax credit that rewards investors for putting money into businesses and real estate projects located in qualified low-income communities. Investors receive a credit equal to 39% of their investment, claimed over seven years. The goal is to draw private capital into areas that conventional lending tends to pass over.

The program is run by the CDFI Fund, part of the U.S. Treasury. The CDFI Fund does not hand money to projects directly. It awards credit allocations to intermediaries, and those intermediaries pick the projects.

The players in an NMTC deal

• The investor: usually a bank or large corporation with a federal tax bill. It buys the credits.
• The CDE: a Community Development Entity that has won an allocation from the CDFI Fund. It takes the investor’s money and lends or invests it into a qualifying project.
• The QALICB: a Qualified Active Low-Income Community Business. This is the business or property owner that receives the financing. It has to be located in a qualifying census tract and meet several operating tests.

Some uses are excluded. Residential rental property generally does not qualify, and the statute specifically rules out certain businesses like golf courses, country clubs, and liquor stores.

How the credit is claimed

The investor makes what is called a Qualified Equity Investment in the CDE. The 39% credit is then claimed on this schedule:

1. Years 1 through 3: 5% of the investment each year.
2. Years 4 through 7: 6% of the investment each year.

That adds up to 39% over the seven year compliance period. If the project falls out of compliance during those seven years, the credits can be recaptured. That is why the paperwork is heavy and the investors are careful.

A simple example

Say a company plans a $10 million manufacturing building in a qualifying tract. A CDE uses $10 million of its allocation on the deal. The investor earns $3.9 million in credits over seven years.

The investor pays something less than face value for those credits, because it is waiting years to use them. After the investor’s pricing and the transaction costs, the project typically nets a subsidy of roughly 15% to 20% of project cost. On a $10 million building, that is about $1.5 million to $2 million the owner does not have to borrow or bring as equity. These numbers are illustrative only. Every deal prices differently.

The subsidy usually shows up as a loan that is forgiven or bought back cheaply at the end of the seven years. That piece is what makes the math work for the owner.

Does a property qualify?

Qualification starts with the census tract. A tract generally qualifies as a low-income community if its poverty rate is at least 20%, or if its median family income is at or below 80% of the relevant area or statewide median. Some tracts also qualify under special rules.

You cannot tell from driving by. The CDFI Fund publishes a mapping tool where you enter an address and it tells you whether the tract qualifies and how distressed it is. More distressed tracts tend to compete better for allocation.

Location is only the first gate. The project also needs a CDE willing to commit allocation, and CDEs have far more requests than credits. They look for projects with clear community benefits, like jobs, health care, or services the area lacks.

What this means for North Idaho projects

Kootenai County has seen strong growth and a lot of new commercial construction. That growth does not automatically rule NMTC in or out. Some tracts in our region may qualify and many will not, and the only way to know is to check a specific address in the CDFI Fund mapping tool.

If a site does qualify, the next question is size. Legal and accounting costs for an NMTC deal are significant, so the program tends to fit projects in the several million dollar range. A small retail pad in Post Falls is unlikely to justify the effort. A larger industrial, health care, or community facility project might.

The other point I make with clients is timing. NMTC deals take months to put together. If you need to break ground next quarter, this is probably not your tool.

A note before you go further

This is a general overview, not tax or legal advice. NMTC structures are complex, and anyone serious about the program should talk with a CPA and an attorney who handles NMTC transactions.

If you have a project in Coeur d’Alene, Hayden, or elsewhere in Kootenai County and want a second set of eyes on whether NMTC is worth exploring, I’m happy to walk through it with you.