New Markets Tax Credit Transactions

The New Markets Tax Credit Program

The New Markets Tax Credit (NMTC) program, established under Section 45D of the Internal Revenue Code, provides federal credits to investors that make qualified equity investments (QEIs) in certified Community Development Entities (CDEs). A CDE must use substantially all of the QEI proceeds to make qualified low-income community investments (QLICIs), such as qualifying loans or equity investments in businesses operating in low-income communities.

The credit equals 39% of the QEI and is claimed over seven years — 5% in each of the first three credit-allowance years and 6% in each of the final four. In the common leverage structure, investor equity and leverage-loan proceeds are combined at an investment fund, which makes the QEI into one or more CDEs. The project-level benefit is then delivered through the CDE's QLICIs, often in the form of loans with terms that are more favorable than conventional financing.

NMTC allocation authority is awarded competitively by the CDFI Fund to CDEs through allocation rounds, which are not necessarily conducted on an annual one-year basis. A project seeking NMTC-enhanced financing must identify a CDE with available allocation authority and satisfy that CDE's eligibility, underwriting, community-impact, and mission requirements.

The NMTC Transaction Structure

Unlike LIHTC, NMTC does not ordinarily place the investor directly into the project ownership entity. In the common leverage structure, the investor and leverage lender fund an investment fund, the investment fund makes a QEI into one or more CDEs, and the CDEs make QLICIs to the qualifying project business. QLICIs may include loans, equity investments, and other qualifying investments.

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 — often the sponsor, project borrower, an affiliate, or another financing source — makes a leverage loan to the investment fund.
The NMTC investor contributes equity to the investment fund. That fund-level contribution is not itself the QEI.
The investment fund combines the leverage-loan proceeds and investor equity and makes the QEI into one or more CDEs. The federal credit is calculated on the QEI in the CDE.
The CDE uses substantially all of the QEI proceeds to make one or more qualified low-income community investments (QLICIs).
The QALICB receives the project-level benefit through the QLICIs, which may be loans, equity investments, or other qualifying investments with terms structured for the transaction.

The investment fund's combined leverage-loan and investor-equity proceeds generally fund the QEI into the CDE. The CDE must then deploy substantially all of the QEI proceeds into QLICIs. Fees, reserves, multiple CDEs, and multiple QLICIs can cause the QEI and project-level investment amounts to differ; the leverage loan, investor equity, QEI, and QLICI amounts should not be treated as automatically identical.

The Seven-Year Compliance Period

The seven-year NMTC credit period begins on the original issue date of the QEI. Statutory recapture may occur if the CDE ceases to qualify as a CDE, if the CDE fails the requirement to use substantially all of the QEI proceeds for QLICIs, or if the CDE redeems the QEI. Project-level QALICB compliance is important because a failure can cause the CDE's QLICI or substantially-all tests to fail.

After the seven-year period, the parties implement the exit provisions negotiated at closing. Depending on the structure, the investor's interest may be transferred under a put, call, or other arrangement, and the leverage loan, QLICIs, and investment-fund entities may be repaid, refinanced, restructured, assigned, or dissolved. Neither a nominal investor buyout nor forgiveness of project debt is automatic; the result depends on the documents, tax analysis, and economic terms of the transaction.

The Economic Benefit: Below-Market Financing

The project's economic benefit depends on the amount and terms of the QLICIs, transaction fees, investor pricing, leverage-loan terms, reserves, and exit structure. QLICIs may offer below-market interest, longer amortization, interest-only periods, subordinate security, deferred principal, or other flexible terms, but no single pricing or forgiveness formula applies to every transaction.

Sizing requires coordination of available allocation authority, investor equity, leverage funding, the amount that the CDE must deploy into QLICIs, project debt capacity, and the seven-year compliance requirements. Any estimate of "net benefit" should be identified as transaction-specific and supported by the applicable financial model.

Eligible Projects and Uses

NMTC financing generally targets businesses and projects in low-income community census tracts meeting the poverty-rate or median-family-income tests in Section 45D, together with any applicable statutory, regulatory, and allocation-agreement requirements. Eligibility must be confirmed using the applicable census data and CDFI Fund guidance.

NMTC has been used for community facilities, health centers, educational facilities, grocery stores, mixed-use commercial projects, and manufacturing and industrial facilities. The rental of residential rental property generally is not a qualified NMTC business. In a mixed-use or affordable-housing development, NMTC financing is therefore generally limited to qualifying nonresidential or community-facility components, subject to tax counsel's analysis.

A QALICB generally must derive at least 50% of its gross income from the active conduct of a qualified business in low-income communities, use at least 40% of its tangible property in low-income communities, and perform at least 40% of its employee services in low-income communities, subject to regulatory deeming rules and additional limitations on collectibles and nonqualified financial property. These requirements must be tested under the applicable regulations for each project.

Combining NMTC with LIHTC and Other Credits

NMTC may be layered with LIHTC or HTC in mixed-use, historic, or community-facility projects. Each program has distinct ownership, tax, financing, and compliance requirements, and the parties and entities may be separate or overlapping depending on the structure.

NMTC and Affordable Housing

Because residential rental activity generally is excluded from qualified NMTC business activity, NMTC financing in an affordable-housing development usually applies to a separately analyzed nonresidential component, such as a clinic, childcare center, community facility, or commercial space. The NMTC and LIHTC components may require separate entities, cost allocations, collateral arrangements, and document packages.

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 projects in low-income communities may combine NMTC and HTC. Where an HTC lease-pass-through structure is used, the master-tenant and QALICB arrangements must be coordinated with the QEI and QLICI structure, the allocation of residential and nonresidential costs, and the financing and collateral package. Tax counsel must confirm that each entity and activity satisfies the applicable program requirements.

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 and investor admission documentation
Investor subscription and equity-contribution documentation at the investment-fund level
QEI documentation between the investment fund and each CDE
QLICI loan or investment documents between each CDE and the applicable 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, source-control, and collateral arrangements among the leverage lender, CDEs, QLICI lenders, and other project lenders where applicable
Exit and unwind documentation, including any refinancing, repayment, assignment, or restructuring arrangements

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, or other negotiated investor-exit documentation after the seven-year period
Refinancing, repayment, assignment, or restructuring documentation for QLICIs and leverage debt
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. Transaction counsel may assist with structure and diligence before commitment and then document the transaction once allocation and business terms are established.

NMTC Counsel at Snow LLP

The firm 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. This 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 specialized tax analysis and may require tax opinions addressing the QEI, CDE, QLICI, QALICB, compliance, and exit structure. Snow LLP coordinates with tax counsel and does not provide tax opinions.

Illustrative Example

A sponsor develops a community facility in a low-income community using NMTC-enhanced financing. A leverage lender makes a loan to an investment fund, the NMTC investor contributes equity to that fund, and the fund combines the proceeds to make a QEI into one or more CDEs. Each CDE uses substantially all of its QEI proceeds to make one or more QLICIs — often loans — to the QALICB that owns or operates the project. The investor claims the credit over seven years, while the CDE and project maintain the required qualifications. The leverage loan, fund and CDE documents, QLICIs, project financing, compliance covenants, and exit provisions are coordinated at closing.

This example is a simplified illustration of transaction structure and mechanics. It does not describe an actual engagement, is not legal advice, and does not predict any outcome.