New Markets Initiatives, Renewal Communities and EZ Expansion

Community development practitioners, national retail chain operators, financial specialists and commercial real estate investors have recently created a "buzz" in conversations anticipating the imminent release of regulations implementing the New Markets program allocation regulations.

The legislation, passed at the end of 2000, included the Community Renewal Act and EZ program expansion. New Markets Tax Credits (NMTC) and capacity-building resources catalyzed by these new series of programs are expected to increase the availability of patient capital via equity investments in "Community Development Entities (CDEs) in economically distressed communities. (See the Federal Register of December 10, 2001, vol. 66, No. 84, p. 21846 for information on applying for CDE certification.)

The tax credit will be implemented by the Treasury Department and its Community Development Financial Institutions Fund with the IRS designating a point person to address related tax issues. (The tax credit will comprise a new section 45D of the Internal Revenue Code). The Small Business Administration will manage the New Markets Venture Capital Program and funding for the BusinessLINC initiative which nurtures business-to-business technical assistance (see www.business-linc.org for more information). Details and interim regulations regarding the SBA New Markets Venture Capital (NMVC) program were released in the Federal Register on January 22, 2001 (Volume 66, No.14, pages 7217-7246). SBA modeled much of its regulatory approach on its Small Business Investment Company (SBIC) program. NMVCs are newly-formed, for-profit entities with qualified management "that have economic development as their primary mission, and identify particular low-income geographic areas in which they propose to focus their investment activities." (See sections 108.200-108.240 and 108.340-108.395 for capitalization, matching funds and business plan requirements).

Renewal Communities and EZ Expansion

In addition to the New Markets Tax Credits, Venture Capital and BusinessLINC resources, approximately 40 Renewal Communities have been designated offering zero-rate capital gains for qualifying businesses, wage credits and additional deductions for capital expenditures along with other incentives. Renewal Community champion Congressman J.C. Watts (R-Oklahoma) generated excitement for this initiative in the CDC world as he addressed conference attendees of the National Congress for Community Economic Development in 2000.

Nine New EZs

Nine new Empowerment Zones were recently established as well. Wage credits and tax-exempt bonding provisions which varied in EZ Rounds I and II are now consolidated in the new refinements to the program. Capital gains exclusions for businesses (typically 60% of capital appreciation) complement 0% treatment for reinvestments in zone business expansions. EZs are also extended to 2009.

Qualifying Investments, Community Businesses and Community Development Entities

The New Markets credit is claimed at 5% in years 1-3 and 6% in years 4-7. To stimulate investments the tax credit incentive will have to be focused on deals which will generate positive cash flow and capital appreciation. Newly formed Community Development Entities will need partners, management and outside advisors who have the experience and skills to develop and oversee successful investments in economic development ventures which have the prospects for growth in economically challenged areas.

Unlike affordable housing tax credits (typically valued at approximately 70%) the New Markets Tax Credit can be combined with federal grants and loans featuring credit enhancements and reduced rates. A CDE's track record for providing venture finance and capacity-building to disadvantaged businesses or communities, will also be closely scrutinized by Treasury Department evaluators as well as potential private sector investors. CDC approaches which have pioneered business technical assistance innovations such as the Business Outreach Center (BOC) Network in New York (which served as a model for the BusinessLINC program) or the Community Business Network (CBN) in Boston (coordinated by the Massachusetts Association of CDCs) are expected to attract close attention in the coming months.

Among "qualified" investments are equity or debt provided to any "qualified active low- income community business in a low-income community" (which could conceivably include a shopping center project in a targeted area), the purchasing of certain loans from another CDE, specialized financial counseling or technical assistance and the equity investment or loan into the CDE. "Qualified Active Low-income Community Businesses" are corporations or partnerships where 50% of total gross income comes from the conduct of the business within a low-income community. (See provisions pertaining to commercial property use and improvements, sole proprietorships and exclusions regarding certain types of rental activities and certain trades, which will need to be closely examined as will implications re: branch stores of national chains which can qualify). Low-income communities are typically comprised of census tracts where the poverty rate exceeds 20% or the median income is below 80% of the statewide median or metropolitan area median income (whichever is greater). Other provisions may be applicable for less conventional area designations.

As the latest installment of the regulations become available for review, additional clarification will soon be accessible for potential investors and operators of CDEs. Prominent national intermediaries are expected to pursue certification for various programs and a number of CDCs and CDFIs are considering strategies to form coalitions among peers. Private sector developers and national retailers also seem ready to take advantage of the New Markets Initiative through a range of ambitious endeavors. The challenge of bringing these diverse parties together will hopefully be met in the coming months as different sectors evaluate how best to take advantage of the range of incentives offered by this timely and important legislation.