New Market Tax Credits (NMTCs) are part of a program to attract private investment to low-income communities across the United States. If that sounds familiar, you might be thinking of opportunity zones (OZs). NMTCs and OZs do have overlapping areas, but there are some differences. NMTCs were created in 2000, while OZs were created in 2018 as part of the Tax Cuts and Jobs Act.
Investors who receive NMTCs do not invest directly in businesses. Instead, they go through what’s called CDEs. Let’s see how it all works.
What Are NMTCs, And How Do They Work?
NMTCs are federal tax credits. Meaning they are applied as a tax credit, offsetting federal income taxes.
NMTCs are part of the CDFI or Community Development Financial Institutions Fund, a division of the U.S. Department of the Treasury. NMTCs are sold through CDEs (Community Development Entities). The ability to sell NMTCs is an authority the Treasury Department gives CDEs.
These credits create a measurable difference since they can be tracked. The ultimate goal of NMTCs is to create jobs, goods, and services and eliminate food deserts.
For a business owner that is the recipient of NMTCs, they can fund up to 25% of their project with NMTCs. The remaining 75% of funding can come from investor equity, loans, and other credits and incentives.
CDEs identify potential investors. Investors invest in the CDE in exchange for credits. The CDE is, in a way, like a venture capital fund. It pools investor funds and then distributes them to specific businesses located in low-income communities (LIC). A LIC is one with a poverty rate of 20% or greater or a median family income of 80% or less of the area median family income.
How does the actual development in LIC projects work? A sponsor will identify a project located within a LIC. They may put together up to 80% of the capital. In some cases, the federal government would like to see the same area grow. The government grants certain CDEs the authority to provide tax credits to investors.
The CDE then identifies investors for the project. Those investors provide funds in exchange for NMTCs. Investor funds fill the gap needed to fully fund a project.
The Role Of CDEs
CDEs are the link between investors and tax credits. They take in investor funds and, in return, provide investors with NMTCs. Because of this exchange, CDEs are specialized financial intermediaries. NMTCs are claimed over seven years by investors for up to 39 percent of the original investment.
CDEs use investor funds to invest in qualified businesses and nonprofits. They can complement investor funds with low-interest rate loans.
Are NMTCs Transferable?
The IRS is clear about the transferability of unused NMTCs. In the IRS document titled New Markets Tax Credit, chapter 3, page 33 in the following section states that unused NMTCs cannot be transferred.
Disposition of Investor’s Holding: Treatment of Carry Forwards of Unused NMTC
The investor is entitled to claim carryforwards of unused NMTC from prior tax years to reduce federal income tax liabilities in years subsequent to the disposition. The investor cannot transfer the unused NMTC to the new owner of the qualified equity investment.
NMTCs can be a way for investors to help improve low-income communities and receive tax credits in exchange for their investment. While NMTCs do offer tax advantages, it's best to work with your tax advisor to make sure NMTCs are a good fit.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
