The ABC`s of NMTCs - Fox Rothschild LLP

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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.
The ABCs of NMTCs: An Introduction to New Markets Tax
Credits
© 2010 Fox Rothschild
1
Objectives
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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
2
Road Map
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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
3
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 nonprofit businesses in low-income, economicallydistressed 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
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© 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
9
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
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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
The ABCs of NMTCs: An Introduction to New Markets Tax
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© 2010 Fox Rothschild
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Isles Inc. - Mill One
The ABCs of NMTCs: An Introduction to New Markets Tax
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The Salvation Army – Camden Kroc
Center
 Development of $55 million dollar state-of-theart 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
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© 2010 Fox Rothschild
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TSA Kroc Center
The ABCs of NMTCs: An Introduction to New Markets Tax
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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 artdeco 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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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
The ABCs of NMTCs: An Introduction to New Markets Tax
Credits
© 2010 Fox Rothschild
18
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
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© 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
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© 2010 Fox Rothschild
21
Parties that fill in the gaps
 The “Leverage Lender”
 The “Investment Fund”
 The “Investor”
The ABCs of NMTCs: An Introduction to New Markets Tax
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© 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
23
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
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© 2010 Fox Rothschild
24
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
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© 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 forsale housing units located in LICs.
The ABCs of NMTCs: An Introduction to New Markets Tax
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© 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
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© 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
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© 2010 Fox Rothschild
28
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
30
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
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© 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
32
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
33
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
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© 2010 Fox Rothschild
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IV. Deal Structure
The ABCs of NMTCs: An Introduction to New Markets Tax
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© 2010 Fox Rothschild
35
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 passthrough “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
36
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.
The ABCs of NMTCs: An Introduction to New Markets Tax
Credits
© 2010 Fox Rothschild
37
Putting it in perspective
The ABCs of NMTCs: An Introduction to New Markets Tax
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© 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
39
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
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© 2010 Fox Rothschild
40
Example of Leverage Loan Deal
Structure
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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
42
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
43
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
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© 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 putcall 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
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© 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
46
Counseling a client on the potential
use of NMTCs
 Is the property located in a LIC?
 Does the proposed business (profit or nonprofit) 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
47
Contact Information
Jeffrey M. Hall, Esq.
(609) 895-6755
[email protected]
Daniel V. Madrid, Esq.
(609) 844-7413
[email protected]
The ABCs of NMTCs: An Introduction to New Markets Tax
Credits
© 2010 Fox Rothschild
48
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