Increasing Benefits to QALICB by Using Federal and Kentucky State NMTCs

Published by Rob Bryant on Friday, October 4, 2019
Journal cover thumb October 2019

Question: The Kentucky Department of Revenue (Kentucky DoR) recently announced that 19 community development entities (CDEs) were awarded $3,289,473.68 of state new markets tax credit (NMTC) allocation. How can a Kentucky CDE increase the potential gross NMTC benefit to a Kentucky qualified active low-income community business (QALICB) by using both Kentucky and federal NMTC allocation?

Answer: While it will increase the complexity of the structure, a QALICB can use both federal and Kentucky allocation to fund their project.

The Kentucky New Markets Development program tax credit and the related statutes and regulations thereunder provide for a tax credit in the amount of 39 percent recognized over seven years in the amounts of 0 percent for Years 1-2, 7 percent for Year 3 and 8 percent for Years 4-7 for qualified equity investments (QEIs) made to a qualified CDE. A qualified CDE is then required to use 100 percent of the QEI as a qualified low-income community investment (QLICI) to a QALICB. The definition of a QALICB has the same meaning as defined under Internal Revenue Code Section 45D with the exception that any business (or commonly controlled primary tenant) cannot derive or project to derive 15 percent or more of its annual revenue from the rental or sale of real estate. 

As described above, it would seem to indicate that a Kentucky CDE would be required to directly invest its proceeds from a QEI into a Kentucky QALICB as a QLICI. However, the understanding of the Kentucky DoR’s intent of the program is to work in tandem with the federal NMTC program to result in investments and economic benefits to Kentucky low-income communities. With this intent, the QLICI from the Kentucky CDE can be used as leverage for a federal QEI that will in turn be made as a QLICI to a Kentucky QALICB, which is also known as the “stacked NMTC structure” similar to other state programs. This intent is further illustrated by previous favorable private letter rulings issued by the Kentucky DoR approving this structure. Most, if not all, Kentucky CDEs and their respective tax credit investors will require the Kentucky QALICB and their counsel to request this same favorable ruling for their closing.

For example, let’s assume a Kentucky QALICB has received a letter of intent from a Kentucky CDE in the amount of its awarded allocation of $3,289,473.68 and a letter of intent from a CDE with federal allocation in the amount of $5 million. For simplicity purposes, let’s also assume the QALICB’s budget, inclusive of all NMTC fees and expenses, is also $5 million.  

The stacked structure would start with the Kentucky QEI of $3,289,473.68, which would generate $1,282,894.74 of tax credits that an investor would be allocated over the seven-year credit stream that can be used against Kentucky corporate, individual, limited liability entity and insurance premium taxes. If the investor invests 55 cents per tax credit or $705,592.10, a leverage loan in the amount of $2,583,881.58 would be needed to make the Kentucky QEI. The Kentucky CDE would then use the QEI proceeds to make a loan to a federal investment fund. The federal investment fund would pool together sources to make the federal QEI of $5 million, which would generate $1.95 million of tax credits. If a federal investor invests 82 cents per tax credit or $1.599 million, total leverage in the amount of $3.401 million would be needed to fund the QEI. Since the Kentucky CDE has made a loan to the federal investment fund for $3,289,473.68, an additional leverage loan of only $111,526.32 is needed to fund the federal QEI to the federal CDE. The federal CDE would then make a loan to the Kentucky QALICB of $5 million.

This stacked structure would generate a total of $2,304,592.10 of combined gross federal and Kentucky NMTC benefit to the Kentucky QALICB–or approximately 46 percent of the total budget. 

There is an additional item to consider when utilizing the stacked structure.

The Kentucky CDE generally requires the federal CDE to carve out its allocation as a separate traceable note to the QALICB in case of a redeployment event. This allows the proceeds to be reinvested into another Kentucky QALICB without requiring the federal CDE to reinvest its full $5 million into the same QALICB if their footprint is wider than the commonwealth. 

With great potential gross benefit of using both Kentucky and federal allocation for your NMTC development comes great complexities. Please do not hesitate to reach out to a Novogradac NMTC expert if you have any questions.