The New Market Tax Credit (NMTC) program provides substantial capital to businesses and projects in economically distressed communities, but understanding precisely how the program works requires clarity about what expenses qualify for financing and how tax credit amounts are calculated. Unlike some tax credit programs that provide credits based on specific expenditure categories, the NMTC structure operates through investment capital that businesses deploy across varied expense types, with tax credits calculated on investor contributions rather than business expenses directly. For businesses, developers, and investors evaluating NMTC opportunities, understanding what expenses are covered by New Market Tax Credits and how are they calculated clarifies the program’s mechanics, enables accurate financial modeling, and supports effective transaction structuring aligned with program requirements and business objectives.
The Fundamental NMTC Structure: Investment-Based Rather Than Expense-Based
Understanding what expenses are covered by New Market Tax Credits and how are they calculated begins with recognizing that the NMTC program operates fundamentally differently from expense-based tax credit programs like the Research and Development Tax Credit or Historic Tax Credits. 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 amount equals 39% of the qualified equity investment that investors make in CDEs, claimed over seven years according to a legislatively established schedule. Investors receive 5% credits annually for the first three years and 6% credits annually for the subsequent four years, totaling 39% of their investment regardless of how businesses deploy the capital or what expenses they incur.
This investment-based structure means businesses receiving NMTC financing don’t calculate credits based on their expenses. Instead, investors calculate credits based on their investments in CDEs, and businesses benefit indirectly through the below-market financing terms that the tax credit subsidy enables. A business receiving a $10 million NMTC-financed loan doesn’t claim tax credits itself—the investors who provided capital to the CDE financing that loan claim $3.9 million in credits over seven years.
Qualified Business Property: The Core Expense Category
While NMTC credits aren’t calculated directly from business expenses, program rules strictly govern how businesses must deploy NMTC financing proceeds. The substantially-all test requires that at least 85% of a QALICB’s aggregate gross assets be qualified business property—a requirement that effectively determines which expenses NMTC financing can support.
Qualified business property includes tangible property used in the active conduct of a qualified business, provided the property satisfies specific requirements. The property must be either originally used by the QALICB (acquired new rather than used) or the QALICB must substantially improve the property after acquisition. This requirement ensures NMTC capital supports new economic activity rather than merely transferring ownership of existing assets without improvements.
Understanding what expenses are covered by New Market Tax Credits and how are they calculated includes recognizing that qualified business property encompasses diverse asset categories supporting business operations in low-income communities.
Real Estate Acquisition and Development Expenses
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 from ground up, substantial rehabilitation of existing buildings, building acquisition when accompanied by substantial improvements, and tenant improvements within leased facilities.
Substantial improvement requirements mandate that improvements made to acquired property exceed certain thresholds—typically 100% of the acquisition cost—within specified timeframes. This requirement ensures that purchased buildings undergo meaningful upgrades rather than minimal cosmetic changes. A business acquiring an existing industrial building for $2 million must invest at least $2 million in improvements for the property to qualify, excluding land costs from both acquisition and improvement calculations.
Construction costs qualifying as NMTC-eligible expenses include site preparation and earthwork, foundation and structural systems, building envelope including walls and roofing, mechanical, electrical, and plumbing systems, interior finishes, accessibility improvements, parking and site improvements, utility connections, and landscaping integral to site development.
Development soft costs also qualify including architectural and engineering fees, permits and fees, legal costs related to property acquisition or development, environmental assessments and remediation, appraisal fees, survey costs, and construction period interest on loans financing qualified property development.
Equipment and Machinery Purchases
Equipment and machinery purchases represent major NMTC-eligible expense categories, particularly for manufacturing, healthcare, technology, and other businesses requiring substantial capital equipment investments.
Manufacturing equipment qualifying for NMTC financing includes production machinery and systems, assembly line equipment, quality control and testing equipment, material handling systems, inventory management technology, specialized tools, maintenance equipment, and safety systems supporting operations.
Healthcare equipment encompasses diagnostic imaging equipment, examination room equipment, dental equipment and chairs, laboratory equipment and analyzers, surgical instruments and systems, sterilization equipment, patient monitoring systems, medical records technology, and specialized clinical equipment serving particular medical specialties.
Technology infrastructure supporting business operations qualifies including computer systems and servers, networking equipment and infrastructure, telecommunications systems, point-of-sale technology for retail operations, security systems, and specialized software platforms essential to business operations when capitalized rather than expensed.
Understanding what expenses are covered by New Market Tax Credits and how are they calculated includes recognizing that equipment must be used in business operations within low-income communities. Equipment located outside qualifying census tracts or used for operations outside these communities doesn’t satisfy qualified business property requirements and can’t support substantially-all test compliance.
Furniture, Fixtures, and Equipment
Beyond major machinery, businesses can use NMTC financing for furniture, fixtures, and equipment supporting operational needs. Office furniture and systems, retail display fixtures and shelving, restaurant kitchen equipment and furnishings, healthcare waiting room furniture and patient furniture, warehouse shelving and storage systems, and signage all qualify as tangible property supporting business operations.
These items must be capitalized on business financial statements rather than immediately expensed to qualify as property rather than consumable supplies. Generally, items with useful lives exceeding one year and costs exceeding capitalization thresholds established by business accounting policies qualify for capitalization treatment.
Working Capital and Inventory
NMTC financing can support working capital and inventory expenses within limits established by the substantially-all test and qualified business property definitions. Working capital deployed in active business operations within low-income communities contributes to substantially-all test compliance, though businesses must carefully document that working capital supports qualifying activities rather than passive investment or operations outside target communities.
Inventory purchases qualify when inventory supports business operations within low-income communities. A grocery store using NMTC financing can purchase inventory for sale at its qualifying location, a manufacturer can acquire raw materials for production, and a retailer can stock merchandise—all constituting qualifying uses of NMTC proceeds provided inventory remains deployed in qualifying operations.
Operating expenses covered through working capital include payroll for employees working in low-income community operations, rent for qualifying facilities, utilities supporting business operations, supplies consumed in business activities, insurance premiums, professional services supporting qualifying operations, and marketing expenses promoting business activities serving target communities.
The substantially-all test’s 85% threshold means businesses can deploy up to 15% of NMTC proceeds for expenses that don’t qualify as qualified business property without violating compliance requirements. This flexibility accommodates some administrative expenses, investments supporting broader business operations, or temporary cash holdings during implementation phases.
Transaction Costs and Professional Fees
NMTC transactions generate substantial professional fees and transaction costs that businesses often incorporate into financing structures. Understanding what expenses are covered by New Market Tax Credits and how are they calculated includes recognizing that these costs, while necessary for accessing NMTC financing, create complexity regarding qualified business property treatment.
Legal fees for transaction documentation, closing procedures, and compliance establishment typically range from $75,000 to $200,000 or more depending on transaction complexity. Accounting fees for financial analysis, tax opinions, and structure consultation add $50,000 to $100,000 or more. CDE fees for allocation deployment, underwriting, and transaction management vary widely but commonly total 3% to 6% of total NMTC financing. Appraisal and valuation fees, environmental assessments, market studies, title insurance, recording fees, and various other costs contribute to total transaction expenses often reaching $250,000 to $500,000 or more.
These transaction costs are typically financed through the NMTC structure but create tension with the substantially-all test because they don’t directly constitute qualified business property used in active business conduct. Transactions must carefully structure cost allocation and ensure that transaction costs don’t cause substantially-all test violations during the compliance period.
Calculating Tax Credit Amounts
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
Total: 39% over seven years
Understanding what expenses are covered by New Market Tax Credits and how are they calculated requires recognizing that this 39% credit applies to investor contributions, not business expenses. 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 investment-based incentive rather than expenditure reimbursement. Businesses benefit from favorable financing terms enabled by investor tax credits, but credit amounts don’t increase or decrease based on business spending patterns.
Leverage Loan Integration
Many NMTC transactions include leverage loans from conventional lenders alongside qualified equity investments from tax credit investors. These structures enable total project financing exceeding the qualified equity investment amount while maintaining tax credit benefits calculated solely on 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 from banks. Total project financing reaches $10 million, but credits calculate only on the $7 million equity investment. The business receives the full $10 million in capital while transaction costs and credit value are optimized through the leverage ratio.
Leverage integration doesn’t change how expenses are covered or credits calculated but enables larger projects by supplementing equity investments with conventional debt. Businesses must ensure that all capital—both equity and leverage—deploys to qualified purposes satisfying the substantially-all test throughout the compliance period.
Compliance Period Tracking and Documentation
Throughout the seven-year compliance period, businesses must track asset deployment, maintain documentation proving substantially-all test compliance, and demonstrate ongoing qualification. This tracking requires sophisticated accounting systems that separately identify NMTC-financed assets, monitor asset location and use, track asset purchases and dispositions, calculate aggregate gross assets, and verify that qualified business property consistently exceeds 85% of total assets.
Understanding what expenses are covered by New Market Tax Credits and how are they calculated includes recognizing these ongoing monitoring obligations. Initial compliance at financing closing doesn’t ensure perpetual compliance—businesses must continuously manage asset composition, capital deployment, and qualified property maintenance throughout extended compliance periods.
Prohibited Uses and Restrictions
Certain expenses explicitly cannot be financed with NMTC proceeds including securities purchases, passive real estate holdings without active business operations, 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 rather than financial engineering, wealth transfers, or passive investment strategies inconsistent with program objectives.
Practical Financial Modeling
Businesses modeling NMTC financing should project total capital needs across all expense categories, identify which expenses qualify as qualified business property, calculate whether the 85% substantially-all threshold will be satisfied, account for transaction costs reducing net available capital, and structure financing to optimize both credit realization and business capital deployment. This comprehensive modeling ensures realistic expectations about capital availability and compliance feasibility throughout the program’s complex requirements.