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Developing Imaginative Strategies for Higher Education Institutions to Capitalize on the New Markets Tax Credit Program. June 28, 2007

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Developing Imaginative Strategies forHigher Education Institutions to Capitalize on the New Markets Tax Credit Program

June 28, 2007

Robert Fenning, Old Dominion UniversityMichael J. Goldman, Nixon Peabody LLPJames D. Howard, Jr., TransCapital / Dudley VenturesRobert K. Jenkins, Hampton Roads Ventures, LLC


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Introduction to New Markets Tax Credits

Michael J. GoldmanNixon Peabody LLP


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Overview of NMTC Program

  • Enacted as part of the Community Renewal Tax Relief Act of 2000

    • To encourage investments in low-income communities that historically have had poor access to capital

  • Community Development Financial Institutions Fund (“CDFI Fund”) allocates allocation authority and oversees compliance with NMTC Program rules


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PROCESS OVERVIEW

Step 1: Entities apply to the CDFI Fund for certification as Community Development Entities (“CDEs”)

Step 2: CDEs apply to the CDFI Fund for an award of NMTC allocation authority

Step 3: CDFI Fund selects CDEs to receive NMTC allocations

Step 4: CDEs use allocations to offer NMTCs to investors

Step 5: Investors make Qualified Equity Investments (“QEIs”) in CDEs and are entitled to NMTCs

Step 6: CDEs use QEI proceeds to make Qualified Low-Income Community Investments (“QLICIs”) in Qualified Active Low-Income Community Businesses (“QALICBs”)


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Low-Income Community Defined

  • Census tracts where:

    • Poverty rate equals or exceeds 20%, OR

    • Median income is below 80% of the greater of:

      • Statewide median income if in non-metropolitan area

      • Metropolitan area median income

    • Certain designated “Targeted Populations”

    • Census tracts with less than 2,000 people that are contiguous to a LIC and within an empowerment zone

    • High migration rural counties (use 85% vs. 80%)

    • Special GO Zone rules


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QLICI Defined

  • An equity investment in, or loan to, a QALICB

    • The purchase from another CDE of any loan made by such entity, if the loan is a QLICI when made or purchased

    • Any equity investment in, or loan to, any CDE to the extent the recipient CDE makes a QLICI

    • Financial counseling and other services (“FCOS”) (e.g., advice regarding organization and operation of businesses) to businesses located in, and residents of LICs


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Use of QEI Proceeds

  • “Substantially all” (85%) of each QEI must be invested in QLICIs within one year of the QEI

  • QEI proceeds must “remain” invested throughout the 7-year credit period

  • Reinvestment requirement

    • Years 1-6:

      • Periodic loan repayments may be aggregated for up to 2 years before reinvestment is required

      • Other returns OF capital must be reinvested within one year

    • No reinvestment required in year 7


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QALICB Requirements

  • At least 50% of the business’ gross income is from the active conduct of a qualified business in LICs

  • At least 40% of the use of the tangible property of the business is located in LICs

  • At least 40% of the services provided by the business’ employees are performed in LICs

The gross income test is deemed to be met if eitherthe tangible property or the services test is at 50% or higher


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QALICB Requirements (continued)

  • Gross Income Test

    • Any corporation or partnership (including nonprofits) if at least 50% of total gross income is derived from the active conduct of a qualified business within any LIC

    • 50% test is met if entity can meet tangible property or services test using 50% instead of 40%


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QALICB Requirements (continued)

  • Tangible Property Test

    • At least 40% of the use of the tangible property (owned or leased and on a cost basis) of the business is within any LIC


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QALICB Requirements (continued)

  • Services Test

    • At least 40% of the services performed for the business by its employees (amount paid) is performed in any LIC

    • Employee Test: If business does not have employees, it can meet the Gross Income and Services tests if it meets the Tangible Property test at a minimum of 85%


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QALICB Requirements (continued)

  • In addition:

    • Less than 5% of the average of the aggregate unadjusted basis of the property of the entity is attributable to collectibles

  • Must generate revenues within 3 years

    • Unless a nonprofit and use proceeds in furtherance of nonprofit mission


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QALICB Requirements (continued)

  • Nonqualified Financial Property Test

    • Less than 5% of the average adjusted bases of the property of the entity is attributable to certain nonqualified financial property

      • Includes debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, annuities, and other similar property with a term in excess of 18 months


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QALICB Requirements (continued)

  • Non-Qualified Financial Property

    • Exceptions: reasonable amount of working capital

      • Safe Harbor: for construction loans, if the proceeds of the loan will be expended by the QALICB within 12 months after the loan is made, then it is treated as a reasonable amount of working capital


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QALICB Ineligible Business Activities

  • Operation of residential rental property

    • Buildings which derive 80% or more of gross rental income from residential dwelling units

  • Properties where no substantial improvements are made

  • Development or holding of intangibles for sale or license

  • Operation of certain ineligible businesses

    • Golf courses

    • Race tracks

    • Gambling facilities

    • Certain farming businesses

    • Stores where the principal business is the sale of alcoholic beverages for consumption off premises


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QALICB Rental of Real Property – Tenant Use

  • Loans to/investments in QALICB whose business is the rental of real property is not a QLICI to the extent the QALICB’s tenant’s business includes:

    • Any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or

    • Any store the principal business of which is the sale of alcoholic beverages for consumption off premises


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Residential Rental Property Solutions

  • Derive less than 80% of the gross rental income from housing

  • Master lease to a commercial tenant at a gross rent that is at greater than 20% of building’s gross rents

  • Use residential and commercial condominiums, and have the CDE only invest in the commercial condominium


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QALICB Portions of a Business Rule

  • A CDE may treat any portion of a trade or business as a QALICB if such portion of the trade or business would meet the QALICB requirements if it were separately incorporated

    • To qualify under this rule, the portion of the trade or business must be treated as though it were a separate entity

      • for example, separate books and records must be maintained for such portion of the trade or business


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Other Credits

  • Low-Income Housing Tax Credit (Section 42)

    • Specifically not permitted to the extent the CDE’s debt or equity investment is used to finance a building’s eligible basis under Section 42(d)

    • Simple approach is to separate into condominiums the LIHTC and retail projects, with CDE only financing retail condo unit

  • Electricity Produced From Certain Renewable Sources Tax Credit (Section 45)

    • CDEs may make debt or equity investments that may be used to produce electricity


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Other Credits (continued)

  • Historic Rehabilitation Tax Credit (Section 47)

    • CDEs may make debt or equity investments that may be used to rehabilitate historic buildings and qualify as qualified rehabilitation expenditures

    • Caveat – pursuant to their applications for NMTCs, many CDEs have limited their ability to make significant equity investments, thus requiring use of “sandwich lease” structures

  • Energy Credits (Section 48)

    • CDEs may make debt or equity investments that may be used to place in service “energy property”


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Recapture

  • NMTCs may be recaptured from investors during the 7-year credit period if:

    • The CDE ceases to qualify as a CDE

    • The CDE redeems the investment

    • The substantially all requirement is not met


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Recapture (continued)

  • Other Recapture Issues

    • Not triggered when:

      • Bankruptcy of CDE

      • Business goes out of business

      • Foreclosure of the mortgage on commercial rental real estate

    • Waiver of requirements or extension of deadlines may be requested from IRS to avoid recapture

      • Good cause required

      • Must not frustrate purposes of the NMTC program


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NMTC Structure: Direct Investing

Tax Credit Investor

CDE (Allocatee)

$100

QEI

$39 NMTCs over 7 years

Suballocation of Tax Credit Authority

CDE (Subsidiary)

QLICI (>85% of QEI)

QALICB


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NMTC Structure: Leveraging Debt

Tax Credit Investor

LENDER

$30 equity

$70 loan

Leverage

Fund

$39 NMTCs over 7 years

$39 NMTCs over 7 years

$100 QEI

CDE (Allocatee)

CDE

(Subsidiary)

Suballocation of

Tax Credit Authority

QLICI (>85% of QEI)

QALICB


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NMTC Structure: LIHTC Condominium

NMTC Investor/

Leverage Fund

$39 NMTCs over 7 years

$100 QEI

LIHTC Investor

CDE (Subsidiary)

QLICI (> 85% of QEI)

LIHTC

Partnership

QALICB

Owns Residential Condominium

Owns Commercial Condominium

Mixed Use Building


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NMTC Structure: HTC Passthrough

QLICI

QLICI

QEI

CDE

(Subsidiary)

Tax Credit Investor

Managing Member

(Developer Affiliate)

NMTCs

Non-Member Manager

99.99% Profits & Losses, Fees and Cash Flow

DeveloperEquity

HistoricTax CreditEquity

.01% Credits, Profits & Losses,Fees andCash Flow

100% Credits, Profits & Losses, and Cash Flow

QALICB

Pass-through of Historic Tax Credits & Share of Residual

Single Member LLC

(Disregarded Entity)

Lease Payment &Equity Investment

(.01% interest)

Debt ServicePayments

RentalPayments

LoanProceeds

Sub-Tenants/End Users

Construction/Perm Lender


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Require Additional Information?

Michael J. Goldman

Nixon Peabody LLP

202-585-8289

mjgoldman@nixonpeabody.com

To ensure compliance with IRS requirements, we inform you that any tax advice

contained in this communication is not intended or written to be used, and cannot

be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code

or (ii) promoting, marketing or recommending to another party any transaction or

matter addressed herein.