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Q&A: Using NMTCs to Purchase Existing Buildings

Published by Owen P. Gray, CPA on Sunday, August 1, 2010

Journal cover August 2010   Download PDF

Question: Can you use new markets tax credit (NMTC) financing to purchase an existing building?

Answer: Like most tax issues, the answer is: it depends. Section 3.2 and Schedule 1 of the NMTC allocation agreement outline the authorized uses of an NMTC allocation. The authorized uses are based on the responses the allocatee provided in its NMTC allocation application. Section 3.2 and schedule 1 specifically indicate whether a community development entity (CDE) is authorized to make investments in, loans to, non-real estate qualified active low-income community businesses (QALICBs) and/or investments in, loans to, real estate QALICBs.

Section 3.3 of the NMTC allocation agreement outlines various restrictions on the use of the NMTC allocation. Section 3.3(h) of the NMTC allocation agreement indicates that an allocatee may not use the proceeds of its qualified equity investments to make loans to or investments in QALICBs whose principal business activity is the rental to others of real property unless the proceeds of the loan or investment are primarily used for:

  1. costs in connection with new construction located on such property;
  2. costs in connection with the substantial rehabilitation of such property;
  3. costs in connection with the acquisition and substantial rehabilitation of such property;
  4. acquisition costs in connection with new construction; or
  5. take-out financing for a loan, equity investment, or other financing, the proceeds of which were used for items (1), (2), (3), and/or (4).

The first question the CDE must answer is whether the QALICB’s principal activity is the rental to others of real property. If the answer is no, then there are no restrictions with regard to the acquisition of a building. For example, a loan that is made to a charter school to purchase an existing building , to operate a charter school, would be permitted under sections 3.2 and 3.3 of the NMTC allocation agreement (assuming all other criteria are met).

If the QALICB’s principal activity is the rental of real property to others, additional analysis is needed. If the acquisition is in connection with new construction or substantial rehabilitation then it would be permitted under sections 3.2 and 3.3 of the NMTC allocation agreement (assuming all other criteria are met). (See the June 2010 issue of the Journal of Tax Credits for additional information on the substantial rehabilitation calculation.) For example, a QALICB that spends $1 million on the acquisition of an existing building and incurs an additional $1 million in rehabilitation costs in the 24 months subsequent to receiving the CDE’s loan, would be deemed to have substantially rehabilitated the building and as a result the acquisition and substantial improvement would be authorized under the NMTC allocation agreement.

If the QALICB’s principal activity is the rental of real property to others and the acquisition is not in connection with new construction or substantial rehabilitation, there may be other options. A CDE may be able to use the special purpose entity election contained in section 3.3. The election allows CDEs to treat certain real estate businesses as non-real estate businesses for NMTC compliance purposes. (See the November 2008 and February 2007 issues of the New Markets Tax Credit Report for additional information on the election.) However, one requirement is that the primary tenant must be the operating company that owns or controls the special purpose entity that is leasing the property. As such, this may not be an option in all situations.

CDEs intending to make loans to or equity investments in QALICBs for the purposes of acquisition of real property, need to carefully consider the restrictions contained in section 3.3 before making such loan or equity investment.

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