The New Markets Tax Credit (NMTC) program provides substantial capital to businesses in economically distressed communities. Understanding precisely how the program works requires clarity about what expenses qualify for financing and how tax credit amounts are calculated. This guide explains covered expenses and calculation methods for accurate financial modeling.
The Investment-Based NMTC Structure
The NMTC program operates differently from expense-based tax credit programs. The NMTC doesn’t provide credits based on business expenditures but rather on investor contributions to Community Development Entities (CDEs), which then deploy capital to Qualified Active Low-Income Community Businesses (QALICBs).
The tax credit equals 39% of the qualified equity investment made by investors in CDEs, claimed over seven years. Investors receive 5% annual credits for the first three years and 6% yearly credits for the subsequent four years, totaling 39% regardless of how businesses deploy the capital. This means firms receiving NMTC financing don’t calculate credits based on their expenses—instead, investors calculate credits based on their CDE investments.
Qualified Business Property Requirements
While NMTC credits aren’t calculated directly from business expenses, program rules strictly govern how businesses must deploy financing proceeds. The substantially all test requires that at least 85% of a QALICB’s aggregate gross assets be qualified business property.
Qualified business property includes tangible property used in the active conduct of a skilled business. The property must be either acquired new or substantially improved after acquisition, ensuring NMTC capital supports new economic activity rather than merely transferring ownership of existing assets.
Real Estate Acquisition and Development
Real estate represents one of the most common expense categories supported by NMTC financing. Businesses can use NMTC capital for land acquisition when combined with substantial improvements, building construction, substantial rehabilitation, building acquisition with improvements, and tenant improvements.
Substantial improvement requirements mandate that improvements exceed 100% of the acquisition cost within specified timeframes. A business acquiring an existing building for $2 million must invest at least $2 million in improvements for the property to qualify, excluding land costs. Qualifying construction costs include site preparation, structural systems, building envelope, mechanical and electrical systems, interior finishes, and accessibility improvements. Development soft costs also qualify, including architectural fees, permits, legal expenses, environmental assessments, and appraisal fees.
Equipment, Machinery, and Furnishings
Equipment and machinery purchases represent major NMTC-eligible expense categories. Manufacturing equipment includes production machinery, assembly-line equipment, quality control systems, and material-handling systems. Healthcare equipment includes diagnostic imaging, laboratory, surgical, and patient monitoring systems. Technology infrastructure includes computer systems, networking equipment, telecommunications systems, and specialized software platforms when capitalized.
Furniture, fixtures, and equipment also qualify, including office furniture, retail display fixtures, restaurant kitchen equipment, warehouse shelving, and signage. Items must be capitalized on business financial statements if their useful lives exceed one year. All equipment must be used in business operations within low-income communities to satisfy qualified business property requirements.
Working Capital and Inventory
NMTC financing can support working capital and inventory expenses, subject to the limits established by the substantially all test. Working capital deployed to active business operations within low-income communities contributes to compliance, provided businesses carefully document that it supports qualifying activities.
Inventory purchases qualify when supporting business operations within low-income communities. Operating expenses covered include payroll, rent, utilities, supplies, insurance premiums, professional services, and marketing expenses promoting activities serving target communities. Substantially all tests’ 85% threshold allows businesses to deploy up to 15% of NMTC proceeds for costs that don’t qualify as qualified business property.
Transaction Costs and Professional Fees
NMTC transactions generate substantial professional fees that businesses often incorporate into financing structures. Legal fees typically range from $75,000 to $200,000 or more, accounting fees add $50,000 to $100,000, and CDE fees commonly total 3% to 6% of total NMTC financing. Including appraisals, environmental assessments, title insurance, and other costs, total transaction expenses often reach $250,000 to $500,000 or more. These costs create tension with the substantially all test because they don’t directly constitute qualified business property.
Tax Credit Calculation Formula
The tax credit calculation follows a straightforward formula independent of business expenses. Investors receive credits totaling 39% of their qualified equity investments in CDEs, claimed according to the following schedule:
- Year 1: 5% of qualified equity investment
- Year 2: 5% of qualified equity investment
- Year 3: 5% of qualified equity investment
- Year 4: 6% of qualified equity investment
- Year 5: 6% of qualified equity investment
- Year 6: 6% of qualified equity investment
- Year 7: 6% of qualified equity investment
If investors contribute $10 million to a CDE through qualified equity investments, they claim total credits of $3.9 million over seven years, regardless of whether the business receiving financing spends $8 million, $10 million, or $12 million on various expenses. The disconnect between investor credits and business expenses reflects the program’s structure as an investment-based incentive rather than an expenditure reimbursement program.
Leverage Loans and Compliance
Many NMTC transactions include leverage loans from conventional lenders alongside qualified equity investments. A typical structure might include $7 million in qualified equity investments generating $2.73 million in tax credits over seven years, combined with $3 million in leverage loans. Total project financing reaches $10 million, but credits are calculated only on the $7 million equity investment.
Throughout the seven-year compliance period, businesses must track asset deployment, maintain documentation proving substantially all test compliance, and demonstrate ongoing qualification. This requires sophisticated accounting systems that separately identify NMTC-financed assets, monitor asset location and use, and verify that qualified business property consistently exceeds 85% of total assets. Initial compliance at closing doesn’t ensure perpetual compliance—continuous management is required.
Prohibited Uses and Financial Modeling
Certain expenses cannot be financed with NMTC proceeds, including securities purchases, passive real estate holdings, distributions to owners, loans to related parties, investments outside low-income communities, and expenditures on prohibited business activities, including golf courses, massage parlors, gambling facilities, or liquor stores as principal businesses. These restrictions ensure NMTC capital supports active business development within low-income communities.
Businesses modeling NMTC financing should project total capital needs, identify which expenses qualify as qualified business property, calculate whether the 85% substantially all threshold will be satisfied, and account for transaction costs. For expert assistance navigating these complex requirements, explore our NMTC consulting services, review successful NMTC projects, or request a free project analysis to evaluate your eligibility and capital structure options.