Q&A: Calculating the Intangible: A Look at the Substantially-All Safe Harbor

Published by Owen P. Gray, CPA on Wednesday, December 1, 2010
Journal thumb December 2010

Question: In calculating substantially all using the safe harbor method for purposes of the new markets tax credit, do you include net intangibles or gross intangibles in the calculation?

Answer: Treasury Regulation Section 1.45D-1(c)(1)(ii) requires that a community development entity (CDE) use substantially all of the qualified equity investments (QEIs) that the CDE receives from its investors to make qualified low-income community investments (QLICIs). Substantially all is defined as 85 percent of the QEI. The substantially-all test must be satisfied for each annual period of the seven-year NMTC compliance period. A CDE is permitted to satisfy the substantially-all test using either the direct tracing method or the safe harbor method.  

Under the direct tracing method, a CDE is required to directly trace at least 85 percent of the each QEI to QLICIs. Under the safe harbor calculation, rather than looking at each individual QEI, the CDE looks at the ratio of QLICIs to its total assets. Specifically, the numerator is the CDE’s aggregate cost basis determined under Section 1012 of its QLICIs and the denominator of which is the CDE’s aggregate cost basis determined under Section 1012 in all of its assets.  

As noted above, the basis of the CDE’s assets is measured using their cost basis under Section 1012. It is not computed using the adjusted basis as computed under Section 1011 and 1016. Therefore, when calculating the substantially-all test using the safe harbor method, a CDE would include the gross intangibles in the calculation, not the net of amortization value. 

Example
The following example illustrates the calculation. ABC CDE received a $10 million QEI from its NMTC investor. ABC CDE incurred $100,000 of organizational costs and spent $150,000 on furniture and equipment. ABC CDE used the remaining $9,750,000 to make a seven-year, non-amortizing below market loan to XYZ QALICB. ABC CDE’s balance sheet at its substantially-all testing date reflected the following:

Cash$ 50,000
Note Receivable - XYZ QALICB 9,750,000
Furniture and equipment150,000
Accumulated depreciation(60,000)
Organizational costs100,000
Accumulated amortization(13,333)
Total assets$ 9,976,667
Accounts payable$ 25,000
Members’ equity 9,951,667
Total liabilities and equity$ 9,976,667

In this example, the CDE’s numerator for the safe harbor calculation would be $9,750,000. Its denominator would be $10,050,000 ($9,976,667 + $60,000 + $13,333) and as a result the CDE’s safe harbor substantially-all percentage on that testing date would be 97 percent.