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The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 1 The ABCs of NMTCs: An Introduction to New Markets Tax Credits September.

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Presentation on theme: "The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 1 The ABCs of NMTCs: An Introduction to New Markets Tax Credits September."— Presentation transcript:

1 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 1 The ABCs of NMTCs: An Introduction to New Markets Tax Credits September 30, 2010 Presented by Jeffrey M. Hall, Esq. and Daniel V. Madrid, Esq.

2 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 2 Objectives  What are NMTCs?  When and how can they be used?  Who are the parties to these transactions?  How are these transactions structured?  What are the common deal issues?  How can we use knowledge about NMTCs to help our clients?

3 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 3 Road Map  Part I: Background  Part II: Transactions  Part III: Terminology  Part IV: Deal Structure

4 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 4 I. BACKGROUND  Community Renewal Tax Relief Act of 2000, 26 U.S.C. § 45D.  Other sources: Codified at Section 45D of the Internal Revenue Code. Tax regulations are in Section 1.45D-1 of the Treasury Regulations.  Purpose: Attract private investment to provide capital for specific types of for-profit and non- profit businesses in low-income, economically- distressed communities

5 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 5 General Overview  The NMTC Program provides investors with credits against federal income tax in exchange for capital investments in businesses and commercial projects in low-income communities.  Qualified businesses benefit from the equity investments through additional equity capital.

6 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 6 How NMTC program works

7 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 7 NMTCs: What’s the big deal?  Because the NMTC projects are driven by government money, there is a certain “recession resistant” aspect so long as the NMTC program is extended by Congress  The NMTC program allows private developers to access public funds to make projects in low income communities feasible  The program’s flexible structure allows implementation in a wide variety of projects

8 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 8 What’s in it for the investor?  NMTC Investor can claim a tax credit against income tax (but not AMT)  Credit can be claimed for a seven year period starting on the date the initial “Qualified Equity Investment” is made with the Community Development Entity, and continuing on each subsequent anniversary  The total tax credit is 39% of the QEI - 5% of the QEI is paid in Years % of the QEI is paid in Years 4-7  Unused NMTCs can be carried back 1 year and forward 20 years.

9 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 9 What’s in it for the developer?  Projects that pose too much credit risk may become feasible through the inclusion of NMTC investor equity in the capital stack  Developers typically pay interest-only loan payments during the 7-year compliance period with a balloon payment at the maturity  39% tax credit provides additional funds to capital stack making debt service less expensive

10 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 10 What’s in it for the lender?  Credit under the Community Reinvestment Act (“CRA”) makes the deals particularly attractive to banks as a NMTC investor and/or leverage lender  Required loan amount is reduced by NMTC investor’s equity contribution  In addition to a pledge of membership or other capital interest, collateral can include personal guarantees and pledges of various state and local grants

11 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 11 II. PROJECTS

12 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 12 How we got started?  Isles Inc. - Mill One Project  Redevelopment of 240,000 s.f. deteriorating mill into a “sustainable urban village”  Project will consist of business incubator, arts hub, training center, residential lofts, neighborhood retail and headquarters for Isles operations  Located near Hamilton Township train station on the Northeast Corridor line

13 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 13 Isles Inc. - Mill One

14 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 14 The Salvation Army – Camden Kroc Center  Development of $55 million dollar state-of-the- art 125,000 s.f. Kroc Community Center in Camden, New Jersey on Harrison Avenue in Cramer Hill neighborhood  Project will provide community services, recreational programs, educational program and career counseling to Camden’s residents  Advised TSA on risks and benefits of NMTC financing

15 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 15 TSA Kroc Center

16 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild Market Street Associates  Wilmington, DE project with proposed NMTC financing component  Redevelopment of 400 Block of Market Street  20,000 s.f. project for creation of 14 apartment lofts and 9,000 s.f. commercial retail space  Restoration of original architecture and art- deco façade prompted historic tax credits as part of deal structure

17 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 17 Beneficial Bank – MacDade Darby Shopping Center  42,000 s.f. retail shopping center including Fresh Grocer food market, Popeye's Chicken and Dollar Tree in Darby Borough, Pennsylvania  Represented Beneficial Bank as leverage lender

18 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 18 Future Project Involving NMTC Greater Camden Partnership – Haddon Avenue Transit Village  Located between Our Lady of Lourdes Medical Center and the Ferry Avenue PATCO station  Developer - Grapevine Development  Mixed use project including 150,000 SF office building, 90,000 SF retail with grocer anchor, structured parking and 250 units of workforce housing

19 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 19 Takeaways  Opportunities for financing exist despite down economy  Public-private partnership will drive future development  NMTCs function as only one component of available public financing to assist clients in getting projects financed

20 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 20 III. Terminology: Understanding the Jargon NEED PICTURE HERE – IDEALLY SOMEONE LOOKING CONFUSED.

21 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 21 A world of acronyms  LIC “Low Income Communities”  QALICB “Qualified Active Low Income Community Business”  CDE “Community Development Entity”  CDFI Fund “Community Development Financial Institution” Fund of the US Department of Treasury  QEI “Qualified Equity Investment”  QLICI “Qualified Low Income Community Investment”

22 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 22 Parties that fill in the gaps  The “Leverage Lender”  The “Investment Fund”  The “Investor”

23 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 23 What qualifies as a Low Income Community (“LIC”)? A census tract in which:  the poverty rate is at least 20%; or  the median family income does not exceed 80% of the greater of statewide median family income or the metropolitan area median family income; or  additional areas including certain high migration rural areas, projects that serve targeted populations, and certain zones designated as Empowerment Zones by the Federal Government.

24 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 24 LIC’s in Pennsylvania and New Jersey  City of Philadelphia – 90% qualifies.  Other parts of Pennsylvania - Norristown, PA - Chester, PA - Downingtown, PA  New Jersey - Urban Areas: Camden, Trenton, Newark, New Brunswick, Atlantic City  Stamford, CT

25 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 25 Qualified Active Low Income Community Business (“QALICB”) When does an business enterprise qualify as a QALICB?  at least 50% of the total gross income is derived from the active conduct of a qualified business within any LICs;  a substantial portion (40%) of the use of the tangible property of such entity is within any LICs;  a substantial portion (40%) of the services performed for the entity by its employees is performed in any LICs;  less than 5% of the average of the aggregate unadjusted basis of the property of the entity is attributable to certain collectibles; and  less than 5% of the average of the aggregate unadjusted basis of the property of the entity is attributable to certain nonqualified financial property.

26 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 26 Examples of QALICB’s  an operating business located in a LIC;  a business that develops or rehabilitates commercial, industrial, retail and mixed-use real estate projects in a LIC;  a non-profit that develops or rehabilitates community facilities, such as charter schools or health care centers, in a LIC; and  a business that develops or rehabilitates for- sale housing units located in LICs.

27 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 27 Prohibited businesses  “Sin” businesses: massage parlors, hot tub facilities, tanning salons, liquor stores  Golf courses and country clubs  Businesses that purchase and hold unimproved real estate  Businesses that rent residential property  Banks

28 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 28 What is a Community Development Entity (“CDE”)  CDEs are an essential component to a NMTC transaction  CDEs are the pass-through entity through which NMTCs are allocated to an investor  CDEs can be for profit or non-profit and can be structured as limited liability companies, limited partnerships or corporations

29 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 29 How is a CDE established?  CDE must be certified through CDFI Fund  Competitive application process - CDE must file an application with the CDFI Fund - A CDE that is awarded credits enter into an allocation agreement with the CDFI Fund.

30 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 30 Prior Year Allocations  2002: $2.5 billion dollar aggregate award for 2001 and 2002  2004: $3.5 billion dollar aggregate award for 2003 and 2004  2005: $2 billion dollar award  2006: $4.1 billion dollar award  2007: $3.9 billion dollar award, $400 million of which was specifically allocated for investments in Louisiana, Mississippi and Alabama that were affected by Hurricane Katrina.

31 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 31 Recent Round of Allocations  The American Recovery and Reinvestment Act of 2009 allocated $5 Billion in NMTCs for 2008 and $5 Billion of NMTCs for 2009  Most Recent Application Cycle - $5 billion dollars of allocation authority pending congressional approval applications filed - Requesting total of $23 billion dollars (nearly 5 times the available amount)

32 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 32 Qualifications for a CDE A CDE must  be legally established entity and a domestic corporation or partnership for Federal tax purposes;  have a primary mission of serving or providing investment capital to LICs or Low-Income Persons; and  establish accountability to LICs through representation on its governing or advisory boards.

33 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 33 Qualified Equity Investment (“QEI”)  To be “qualified” the equity investment must be - acquired solely for cash; - designated by the CDE as a QEI; and - used by the CDE to make QLICI.  An investor must make a qualified equity investment in a CDE.  The equity investment must occur within 5 years of a CDE entering into an allocation agreement with the CDFI Fund.

34 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 34 Qualified Low Income Community Investment (“QLICI”)  An investment by a CDE that allows NMTCs to be generated  Typically takes the form of a CDE’s loan or equity investment in a QALICB  Can also less typically take the form of: - An equity investment in or loan to another CDE - Financial counseling or services to businesses and residents in LICs - The purchase from another CDE of a QLICI loan made by the CDE to a QALICB

35 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 35 IV. Deal Structure

36 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 36 Leverage vs. Non-Leverage Structure  A non-leverage structure involves only the investor, the CDE and the QALICB.  The investor provides funding directly to the CDE, which in turn makes QLICI in QALICB.  In the leverage structure, the investor equity and leverage loan are aggregated in a pass- through “investment fund” and distributed as a QEI.  The leverage structure allows an investor to receive NMTCs based on the aggregate QEI.

37 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 37 Non-Leverage Structure 1.A NMTC Investor makes a QEI in a CDE 2.The CDE uses substantially all (85%) of the QEI 3.To make a QLICI (consisting of debt or equity) in a QALICB.

38 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 38 Putting it in perspective

39 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 39 Leverage Structure  Investor makes equity investment into an investment fund  Lender makes a “leverage loan” to investment fund  Investment fund makes QEI comprised of NMTC investor’s equity and lender’s leverage loan into CDE.  CDE uses QEI to make QLICI in QALICB.  Investor receives NMTCs based on the investment fund’s QEI.

40 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 40 How leverage loans are structured  Maturity date of 7 years with additional period to wind up transaction.  Investment fund makes interest-only payments during 7-year compliance period with balloon payment of principal due at maturity.  Collateral is a pledge of the investment fund’s equity interest in CDE.

41 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 41 Example of Leverage Loan Deal Structure

42 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 42 What happens once the deal is closed?  CDE makes a continuous QLICI into the QALICB.  QLICI can be in the form of a construction loan or equity.  QALICB and CDE must continuously keep up with IRS Regulations during 7-year period.  Leverage lender and CDE agree on forbearance on leverage loan and QLICI  Investor may receive distributions from project cash flow

43 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 43 NMTC Recapture  At any time during the 7-year NMTC compliance period all previously-issued NMTCs may be recaptured  QLICIs must be continuously monitored to ensure that the QEIs remain in compliance with the NMTC regulations during the entire 7-year compliance period  NMTC investor may also have to pay interest at the IRS underpayment rate  NMTC investors typically require a guaranty from the borrower for losses due to recapture

44 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 44 Events triggering recapture  Recapture can occur in any of the following circumstances: - The CDE ceases to be a CDE - The CDE ceases to use “substantially all” of its cash for making a QLICI - An investor redeems an equity investment in a CDE

45 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 45 Winding Up the Transaction  Leverage loan is repaid or refinanced after expiration of interest-only period  Investment fund is unwound pursuant to put- call agreement: - Put: Investor can exercise “put option” requiring QALICB entity to purchase investor’s interest in investment fund for agreed-to purchase price. - Call: QALICB entity can exercise call mechanism requiring investor to sell entire equity interest in investment fund for agreed purchase price.

46 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 46 Issues  Getting comfortable with the collateral  Complicated deal structure – too many chefs in the kitchen  Tax expertise is a necessity for advising CDEs or NMTC investors  Transactional Fees: CDE fees, legal and accounting fees  Seven year lockout  Potential for recapture

47 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 47 Counseling a client on the potential use of NMTCs  Is the property located in a LIC?  Does the proposed business (profit or non- profit) qualify as a QALICB?  Prepare your presentation (project description, sources and uses, creditworthiness).  Put together the team: CDE, investor, lender, attorneys, accountants (for financial modeling) and consultants (for brokering deals).  Identify other available tax credit programs and sources of public financing.

48 The ABCs of NMTCs: An Introduction to New Markets Tax Credits © 2010 Fox Rothschild 48 Contact Information Jeffrey M. Hall, Esq. (609) Daniel V. Madrid, Esq. (609)


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