Not-for-Profits Can Utilize New Markets Tax Credits to Fill Fundraising Gaps

The current economic downturn has impacted the ability of not-for-profits to raise funds sufficient to meet the needs of their programs. As a result, many nonprofits have been forced to delay planned development projects. The New Markets Tax Credit program may provide a financing bridge to fill the gap left by shortfalls in fundraising from traditional sources.

Since its creation by Congress in December 2000, the New Markets Tax Credit (NMTC) program has attracted significant investment in low-income communities. Recently, the number of not-for-profit organizations benefiting from the NMTC program has increased significantly as they have discovered how to utilize NMTCs to fill fundraising gaps. At the same time, for-profit businesses have faced increasing difficulty obtaining the debt financing that provides the leverage required for them to utilize the NMTC program. Since not-for-profit organizations are typically less reliant upon debt financing when undertaking a construction project, not-for-profit organizations have found it easier to attract NMTC allocation to their projects, thus taking advantage of the decrease in competition from the private sector.

Overview of the NMTC Program

Congress recently renewed the NMTC program and for 2009 alone has authorized $5.0 billion of NMTC allocation that will result in approximately $2.0 billion of tax credits. Since the program’s inception, Congress has given the Department of Treasury the authority to grant NMTC alloca¬tions that will result in more than $10 billion in tax credits to taxpayers who make investments in conduit entities that in turn make investments in or loans to qualified businesses or organizations located in low-income communities.

NMTCs are equal to 39 percent of the amount invested in a conduit entity known as a CDE (Com-munity Development Entity) that has received an allocation of NMTCs from the CDFI Fund of the Department of Treasury. Investors claim the credits over a seven-year period, beginning with the date of the initial investment. Substantially all of the qualified equity investment must in turn be used by the CDE to provide investments in low-income communities. Authority to provide NMTCs is awarded annually to CDEs under a competitive application process. To date, the CDFI Fund has made 364 awards totaling approximately $7.6 billion in available tax credits.

Benefits to Nonprofit Organizations

Many nonprofit organizations located in low-income areas qualify to receive an enhanced loan from a CDE that has an allocation of NMTCs. Each CDE has a unique strategy to maximize the economic impact of its NMTC alloca¬tion upon the low-income communi¬ties that it serves. Many CDEs have adopted a strategy that allows them to provide financing for real estate development projects undertaken by nonprofit organizations. In addition, many not-for-profit organizations have established CDEs and received allocations of NMTC investment authority from the CDFI Fund to assist them in furthering their mission.

Examples of projects sponsored by nonprofit organizations that have taken advantage of the NMTC program include theaters, community centers, healthcare facilities, business incubators, human service agency facilities, charter schools, day-care facilities, and local YMCAs. There is no restriction on what kind of nonprofit organization can utilize NMTCs—as long as they meet the NMTC eligibility requirements. It is important to note that while investments in residential rental real estate are not eligible for NMTCs, a mixed use facility can qualify for NMTCs as long as the rental income from the residential portion of the building is less than 80 percent of the building’s gross rent revenue during the entire seven-year NMTC compliance period.

Since the tax credit investor’s rate of return is subsidized by the tax credits, CDEs are able to use the proceeds from the syndication of the NMTCs to make loans to qualified nonprofit organizations that can be forgiven after seven years. Net of transaction and administrative costs, a non-profit organization can utilize the NMTC program to raise permanent capital exceeding 20 percent of the total loans received from the CDE.

Tax credit investors typically utilize an “Investment Fund” to raise the capital to be contributed to the CDE. Typically 25 to 30 percent of the Investment Fund’s capital is raised in the form of equity from the tax credit investor who provides capital in exchange for the NMTCs. The Investment Fund borrows the remaining funds, typically from a lender that would have otherwise made a loan directly to the project. This is where nonprofit organizations have recently gained a competitive advantage against for-profit developers who are seeking to take advan¬tage of the NMTC program but are having a difficult time obtaining debt financing.

Nonprofit organizations can often use funds received in con-nection with a capital campaign or a related bridge loan to make the loan to the Investment Fund. Such ready access to financing is very appealing to CDEs, since CDEs are generally motivated to deploy capital into low-income communities as quickly as possible.

Eligibility Requirements

Nonprofit organizations must meet the following two eligi-bility requirements to qualify under the NMTC program:

1. The organization must be located in a census tract with either (1) a poverty rate of at least 20 percent, or (2) a median income less than 80 percent of the median income for the area. However, most CDEs commit to utilize a substantial portion, if not all, of their NMTC allocation in low-income communities that meet certain criteria demonstrating higher distress, including poverty rates of at least 30 percent and median family income less than 60 percent.
2. The organization must have a substantial connection to the location, as measured by the source of the orga-nization’s revenue, the location of its property, and/or the geographic area where its employees provide their services.

How to Access NMTC Capital

A nonprofit organization that desires to access funds from the NMTC program would first need to determine if its project qualifies and would then need to identify CDEs with an allocation of NMTCs that are willing to enhance the project’s financing with NMTCs. Information regarding CDEs that have been allocated NMTCs is available at www.cdfifund.gov.