The New Market Tax Credit (NMTC) and Opportunity Fund Investing: What You Need to Know
The New Markets Tax Credit (NMTC) encourages investment and development in low income communities by offering tax credits to investors who make equity investments in specialized investment vehicles referred to as Community Development Entities (CDEs). Investors can claim a 39% credit (of equity invested) over a 7-year period. The NMTC program has helped create 178 million sq. ft. of commercial space and has financed more than 5,000 businesses. In comparison, the Opportunity Zones (O-Zones) program allows investors to defer or reduce their capital gains taxes by investing in an Opportunity Fund, a specialized investment vehicle that has invested 90% of its assets into a Qualified Opportunity Zone (QOZ), one of 8,700 low-income census tracts througout the U.S.
Combining The NMTC and O-Zones Programs
In order to qualify for NMTCs, a Community Development Entity must compete with other CDEs for a limited number of tax credits. CDEs accept money from investors and offer them New Markets Tax Credits in exchange for investing in the Community Development Entity. They use this equity to lend to businesses at low rates to encourage them development of low income communities.
Since approved areas for the New Markets Tax Credit also have low median incomes, there is a natural overlap between many NMTC areas and Opportunity Zones. While the NMTC is claimed over a seven year period, many investors might want to keep their capital in an Opportunity Fund for 10 years or longer. By doing so, they can take advantage of the fact that Opportunity Funds allow investors who keep their investments for at least 10 years to avoid paying any capital gains taxes on the appreciation their investment has experienced while in the Opportunity Fund.
NMTCs and LIHTCs Can Be Combined for Maximum Tax Benefits
Like NMTCs, the Low Income Housing Tax Credit (LIHTC) program is a popular tax credit program which offers investors a dollar-for-dollar federal income tax credit for investing in affordable housing properties. While New Markets Tax Credits are generally for commercial real estate, and LIHTCs can only be used for affordable residential real estate, these programs can actually be combined in certain situations. For example, a mixed-use property that’s legally divided into a “condominium structure” with two ownership entities can have a Commercial Development Entity owning the commercial part of the property (using NMTCs), and the residential part of the property using LIHTCs. In theory, both of these entities could be owned by an Opportunity Fund (given the property was located in a Qualified Opportunity Zone), but this could create significant legal complexities and would require a high degree of tax planning.