New Markets Tax Credit Transactions

The New Markets Tax Credit Program

The New Markets Tax Credit (NMTC) program, established by Congress in 2000 under Section 45D of the Internal Revenue Code, is designed to stimulate investment in low-income communities by providing a federal tax credit to investors who make qualified equity investments in certified Community Development Entities (CDEs). CDEs use those investments to provide below-market financing to businesses and real estate projects in qualifying low-income community census tracts.

The NMTC generates a 39% credit against the investor's federal tax liability, claimed over seven years — 5% per year for the first three years, then 6% per year for the final four years. The credit is calculated on the amount of the qualified equity investment (QEI) made into the CDE. The economic benefit to the project is delivered not through equity, but through below-market debt — typically a loan at a significantly reduced interest rate, often with deferred principal repayment — which reduces the project's overall debt service and improves financial feasibility.

NMTC allocation is competitive. The CDFI Fund within the U.S. Department of the Treasury allocates NMTC authority to CDEs through an annual application process. CDEs awarded allocation then deploy that allocation into qualifying projects at their discretion. A project seeking NMTC financing must identify a CDE willing to deploy allocation into the project — which requires the project to meet the CDE's underwriting criteria and mission alignment requirements.

The NMTC Transaction Structure

The NMTC transaction structure is among the most complex in community development finance. Unlike LIHTC, which delivers equity to a project entity, NMTC delivers its benefit through a structured lending arrangement involving multiple tiers of entities and loan obligations. Understanding the structure is essential to understanding the legal work.

The Leverage Loan Model

The standard NMTC structure — commonly called the leverage loan model or "typical" NMTC structure — involves the following flow of funds and entities:

The leverage lender — typically the project borrower or a lender affiliated with the project — makes a loan (the "leverage loan") to an investment fund entity (the "investment fund" or "leverage fund LLC").
The NMTC investor makes a qualified equity investment (QEI) into the same investment fund entity. The investor's QEI — not the leverage loan — is the amount on which the 39% credit is calculated.
The investment fund uses the combined proceeds of the leverage loan and the QEI to make a qualified equity investment into one or more CDEs.
The CDE uses the proceeds to make a qualified low-income community investment (QLICI) — typically a below-market loan — to the project borrower (the "qualified active low-income community business" or QALICB).
The QLICI loan to the QALICB is the mechanism through which the NMTC benefit reaches the project — through below-market interest, deferred principal, or other favorable terms that improve project feasibility.

The result is that the project borrower receives financing at favorable terms (the QLICI loan) while the NMTC investor receives a 39% federal tax credit on its QEI. The leverage loan amount plus the QEI amount equals the total QLICI loan amount to the project. The leverage loan is typically repaid from the QLICI loan proceeds as they flow back through the structure, or restructured at the end of the seven-year compliance period.

The Seven-Year Compliance Period

The NMTC is subject to a seven-year compliance period. During that period, the CDE must maintain its qualified equity investment in the QALICB, the QALICB must remain a qualified active low-income community business operating in a qualifying low-income community census tract, and the investment must not be redeemed before the end of the seven-year period. Credit recapture applies if the investment is redeemed or the CDE fails to maintain compliance during the compliance period.

At the end of the seven-year period — commonly referred to as the "NMTC exit" or "unwind" — the structure is dissolved. The typical exit involves the project borrower or an affiliated entity acquiring the investor's interest in the investment fund for a nominal amount (since the investor has claimed all available credits and has little remaining economic interest), and the leverage loan and QLICI loan are repaid, forgiven, or restructured depending on the terms negotiated at closing.

The Economic Benefit: Below-Market Financing

The net economic benefit of NMTC financing to the project depends on the terms of the QLICI loan — typically a below-market interest rate (often 1% or lower), interest-only payments during the seven-year compliance period, and a balloon payment or forgiveness at the end of the compliance period. The present value of the below-market terms, compared to what the project would otherwise pay on market-rate debt, is the effective subsidy the NMTC delivers to the project.

Sizing the NMTC financing involves balancing the amount of allocation available, the QEI the investor will make, the leverage loan amount, and the project's ability to service the QLICI loan during the compliance period. The NMTC benefit is often described in terms of the "net benefit" to the project — the present value of the interest rate reduction over the compliance period — which typically ranges from 15% to 25% of the QLICI loan amount, depending on market conditions.

Eligible Projects and Uses

NMTC financing is available for real estate projects and operating businesses located in qualifying low-income community census tracts — defined as census tracts with a poverty rate of at least 20% or median family income at or below 80% of the area median. Within that geographic constraint, NMTC financing can be used for a wide range of community development purposes.

In the real estate context, NMTC has been used to finance community facilities, health centers, charter schools, grocery stores in food deserts, mixed-use commercial developments, and manufacturing and industrial facilities in low-income communities. NMTC can also be used as a component of mixed-income or affordable housing developments where the project includes a commercial or community facility component — though NMTC cannot be used to finance residential rental housing directly.

The QALICB requirements — including the requirement that substantially all (at least 40% by gross income, or 40% by use of tangible property) of the business's activities take place in low-income communities — are a central eligibility question that must be analyzed for each proposed use. CDEs typically conduct their own eligibility analysis before committing allocation to a project.

Combining NMTC with LIHTC and Other Credits

NMTC is frequently layered with LIHTC and Historic Tax Credits on mixed-use or community facility projects where one component of the development generates housing credits and another generates NMTC or HTC benefits. These layered structures are among the most complex in affordable housing finance, because each credit program has its own investor, its own entity, its own document set, and its own compliance requirements — all of which must be coordinated in a single closing.

NMTC and Affordable Housing

Because NMTC cannot be used to finance residential rental housing directly, NMTC financing in the affordable housing context typically applies to a non-residential component of a larger development — a ground-floor community facility, a health clinic, a childcare center, or a commercial component of a mixed-use building. The NMTC financing structure sits alongside the LIHTC structure for the residential component, with separate entities, separate investors, and separate document packages that must be coordinated at closing.

Structuring the interface between the NMTC and LIHTC components — particularly with respect to the shared physical plant, shared debt, and the allocation of costs between residential and non-residential eligible basis — requires careful attention to both program requirements and the practical realities of a single building with multiple financing structures.

NMTC and Historic Tax Credits

Historic structures in low-income communities are natural candidates for NMTC/HTC combinations. The HTC generates equity through the master tenant structure, and the NMTC provides below-market financing for the non-residential components or the overall rehabilitation. In these transactions, the master tenant (for HTC) and the QALICB (for NMTC) must be structured to satisfy both programs' requirements, which often requires the master lease to be structured to include the commercial components while excluding any residential components that are ineligible for NMTC.

The Legal Work in an NMTC Transaction

NMTC transactions involve a distinct and layered set of legal documents that reflect the multi-tier investment structure. The legal workstreams include:

Investment Fund and CDE Documents

Investment fund LLC operating agreement (leverage lender and investor as members)
Investor subscription and qualified equity investment documentation
CDE investment documents (investment fund to CDE)
QLICI loan agreement (CDE to QALICB)
NMTC compliance and recapture indemnity provisions

Leverage Loan Documents

Leverage loan agreement (leverage lender to investment fund)
Security documents for the leverage lender's position
Intercreditor arrangements between the leverage lender and the QLICI lender (CDE)
Exit loan documentation for the unwind at Year-7

Project-Level Documents

QALICB formation and organizational documents
QLICI mortgage and security documents
Title insurance for the QLICI lender position
Intercreditor arrangements with any other senior or subordinate lenders
NMTC compliance covenants and reporting requirements

Exit and Unwind Documentation

Put/call option for investor exit at Year-7
Exit loan or refinancing documentation to repay QLICI and leverage loan
Entity dissolution or restructuring documents
Coordination with LIHTC or HTC investor documents where credits are layered

NMTC allocation is a scarce resource. Access to NMTC financing depends on identifying a CDE willing to deploy allocation into a qualifying project. CDEs are selective — they receive far more project requests than they have allocation to deploy. Projects that are well-developed, located in high-need census tracts, and aligned with the CDE's stated mission priorities are more likely to secure NMTC commitment. Legal counsel's role begins once the CDE commitment is secured and the transaction structure is being documented.

NMTC Counsel at Snow LLP

Snow LLP advises developers, sponsors, and borrowers on New Markets Tax Credit transactions — including standalone NMTC deals and NMTC transactions layered with LIHTC or Historic Tax Credits. The practice handles the legal workstreams associated with the investment fund structure, the QLICI documentation, the project-level financing, and the coordination of NMTC requirements with the broader transaction structure.

NMTC transactions require tax opinions regarding credit eligibility, the QALICB qualification, and the investment structure. Tax counsel coordinates with the transaction team; Snow LLP does not provide tax opinions.