NMTC Working Group Update: October 2011

Published by Brad Elphick on Saturday, October 1, 2011
Journal thumb October 2011

In June, the Internal Revenue Service (IRS) released two notices regarding potential ways to encourage non-real estate investments under the New Markets Tax Credit (NMTC) program. The first notice, a notice of proposed rulemaking (NPRM), contained proposed regulations and invited comments on the proposed changes. The second notice, an advance notice of proposed rulemaking (ANPRM), invited comments on potential changes for which the IRS is considering issuing proposed regulations.

Both notices focused on changes that could be made to the NMTC program to encourage more investments in non-real estate businesses whose “predominant business activity (measured by more than 50 percent of the business’ gross income) does not include the development (including construction of new facilities and rehabilitation/enhancement of existing facilities), management, or leasing of real estate. The purpose of the investment or loan must not be connected to the development (including construction of new facilities and rehabilitation/enhancement of existing facilities), management, or leasing of real estate.”

Investors have typically favored real estate investments for various reasons, including compliance. The NPRM proposed several changes regarding the reinvestment requirement for investments in non-real estate businesses. The ANPRM requested comments on potential changes to the substantiation requirements for second-tier CDEs that make investments in non-real estate businesses.

While the NMTC Working Group commends the Department of Treasury and IRS for its continuing efforts to improve and clarify administrative and tax guidance for the NMTC program in order to ensure its continuing success, the members believe that the proposed changes would do little to encourage more non-real estate investments. In addition to the notices, there will be a public hearing to discuss these issues. Michael Novogradac, the Working Group’s advisor on industry and governmental affairs, will attend the public hearing to give oral statements on the comments prepared by the NMTC Working Group.

While the Working Group agrees that changes need to be made in order to encourage more investments in non-real estate qualified active low-income community businesses (QALICBs), it does not believe that any changes will cause a substantial increase in investments made until a single component of the program is changed that affects all investments — that being tax credit recapture. By having full recapture risk, plus interest penalties for the full term of the seven-year compliance period, the NMTC program requires an extremely high level of compliance and transaction structuring that is unrivaled by other tax credit programs. While this level of structuring and underwriting ensures that the goals of the NMTC program are ultimately achieved, it’s reached at a cost that reduces the net benefit received by the qualified business. A reduction in tax credit recapture risk during the term of the investment would certainly lower the cost of transactions and broaden the types of investments that tax credit investors and CDEs are willing to make, including investments in non-real estate QALICBs.  

Whether recapture is triggered by redemption or failure of the substantially all test, the risk is that a $1 mistake can cause total recapture. If the goal is to promote changes to the program to encourage more investments in operating businesses, the NMTC Working Group believes changes to the calculation of the amount of recapture triggered by these recapture events needs to be changed using a less draconian approach. The NMTC Working Group members recommended that the amount of recapture be calculated similar to other tax credit programs such as the low-income housing tax credit and historic tax credit in which the amount of credits subject to recapture over time. Currently, the same amount of NMTCs are subject to recapture regardless of whether it’s year one or year six.

Without substantive changes to reduce the recapture risk of NMTC transactions, we believe that any changes made to other parts of the regulations will achieve limited results and will not cause investors and CDEs to significantly increase the amount of investments made with non-real estate operating business QALICBs. The NMTC Working Group did prepare responses to each of the questions posed in the notices but believes that the focus should be on the bigger issue – recapture.

Are you an allocatee? Would you like to be part of our group and get the inside track on issues affecting the NMTC Program? Are you a professional that works with NMTC industry participants? Do you have questions about technical program issues you are dealing with? Do you have a great community impact project struggling with a technical issue and can’t move forward until the issue is resolved? Join the NMTC Working Group today and add your issues to the agenda and be part of a strong and active voice in the NMTC industry. For more information about becoming a member please send Cyle Reissig an email at [email protected].