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The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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The ABCs of NMTCs: An Introduction to New Markets Tax Credits
September 30, 2010Presented by
Jeffrey M. Hall, Esq.and
Daniel V. Madrid, Esq.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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?
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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Road Map
Part I: Background Part II: Transactions Part III: Terminology Part IV: Deal Structure
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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How NMTC program works
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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 1-3- 6% of the QEI is paid in Years 4-7
Unused NMTCs can be carried back 1 year and forward 20 years.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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II. PROJECTS
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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Isles Inc.
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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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Isles Inc. - Mill One
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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TSA Kroc Center
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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400 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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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III. Terminology: Understanding the Jargon
NEED PICTURE HERE – IDEALLY SOMEONE LOOKING CONFUSED.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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”
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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Parties that fill in the gaps
The “Leverage Lender” The “Investment Fund” The “Investor”
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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- 250 applications filed- Requesting total of $23 billion dollars (nearly 5 times
the available amount)
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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IV. Deal Structure
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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Non-Leverage Structure
A NMTC Investor makes a QEI in a CDE
The CDE uses substantially all (85%) of the QEI
To make a QLICI (consisting of debt or equity) in a QALICB.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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Putting it in perspective
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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Example of Leverage Loan Deal Structure
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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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.
The ABCs of NMTCs: An Introduction to New Markets Tax Credits
© 2010 Fox Rothschild
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Contact Information
Jeffrey M. Hall, Esq.(609) 895-6755
jhall@foxrothschild.com
Daniel V. Madrid, Esq.(609) 844-7413
dmadrid@foxrothschild.com
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