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Taxpayers’ Qualified Equity Investment (QEI)

Qualified Equity Investment (QEI) Defined
The actual cash investment made by the investor to the CDE, which is referred to as the equity investment, is the first step in defining a QEI. This cash investment eventually qualifies for the NMTC provided that the CDE makes qualified low income community investments (QLICIs).

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A QEI is, in general per Section 45D(b)(1), any equity investment in a CDE if:

• 1. Such investment is acquired by the investor at its original issue (directly or through an underwriter) solely in exchange for cash to the CDE or on behalf of the CDE.

  • The equity investment can be for any stock in a CDE that is a corporation for federal tax purposes (other than non-qualified preferred stock under IRC §351(g)(2)) and any capital interest in a CDE that is a partnership for federal tax purposes.,

• 2. Substantially all (at least 85%) of the cash is used by the CDE to make qualified low-income community investments (QLICI), and

  • Equity investments issued more than 5 years after the CDE enters into an allocation agreement are not QEIs.

  • A CDE that has received an allocation cannot make a QEI in another CDE. A CDE cannot issue more QEIs than the NMTC awarded under the allocation agreement. 

• 3. The investment is designated by the CDE as a QEI  under IRC §45D on its books and records using any reasonable method.

  • ​Generally, an equity investment is not eligible to be designated as a QEI if it is made before the CDE enters into an allocation agreement with the CDFI Fund.

  • However, there are exceptions as listed in Treas. Reg. §1.45D-1(c)(3)(ii) for investments made after April 20, 2001, and allocation applications submitted by August 29, 2002, or for investments made after the date of the Notice of Allocation Availability is published in the Federal Register.​

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Qualified Low-Income Community Investment (QLICI)

QLICI Defined
The CDE must invest the QEIs in QLICIs. The investments can be:

• a. A capital or equity investment in, or loan to, any qualified active low-income community business (QALICB) (as defined in § 45D(d)(2)).

• b. The purchase from another CDE of any loan that was a QLICI either at the time the loan was made or at the time the CDE purchases it. It is not necessary for the CDE from which the loan is purchased to have received an NMTC allocation. 

  • See Treas. Reg. §1.45D-1(d)(1)(ii)(B) if the original loan was made before the CDE was certified. See Treas. Reg. §1.45D-1(d)(ii)(1)(C) regarding multiple purchases of a loan, and Treas. Reg. §1.45D-1(d)(1)(ii)(D) for examples.

• c. Providing financial counseling or other services to qualified active low-income community businesses located in, or residents of, a low-income community.

• d. An equity investment in, or loan to, another CDE, but only to the extent that the second, third or fourth CDE uses the investment or loan to make a QLICI. See Treas. Reg. §1.45D-1(d)(1)(iv) for complete discussion and examples of investments by CDEs in other CDEs.

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Low-Income Community (LIC) Defined
Under IRC §45D(e)(1), a low-income community is identified by population census tract.

• a. The poverty rate for the tract is at least 20%, or

• b. The tract is not located within a metropolitan area and the median family income does not exceed 80% of the statewide median family income, or

• c. The tract is located within a metropolitan area and the median family income for such tract does not exceed 80% of the greater of statewide median family income or the metropolitan area median family income.

• d. In the case of census tracts located in a possession of the United States, possession-wide median family income is used for (b) and (c) above.

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Finding a Low-Income Community (LIC)

• See CDFI Information Mapping System (CIMS) link which indicates whether a census tract qualifies as an LIC

• Additional information and guidance is also available at “Program Eligibility Guidance”link.​​

 

A census tract with a population of less than 2,000 is treated as a low-income community if it is within a empowerment zone under IRC §1391 and is contiguous to one or more low-income communities. For census tracts within high migration rural counties, the median family income cannot exceed 85% of the statewide median family income. A high migration county is any county which, during the 20-year period ending with the year the most recent census was conducted, has a net out-migration of inhabitants from the county of at least 10% of the population of the county at the beginning of the 20-year period. 

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In the event that an area is not tracted for population census tracts, equivalent county divisions can be used. The county divisions must be those used by the Bureau of Census to determine poverty areas.

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Targeted Populations
After October 22, 2004, IRC §45D(e)(2) instructs the Secretary to provide regulations under which targeted populations may be treated as low-income communities. No regulations have been issued to date, but the IRS has issued Notice 2006-60, 2006-2 C.B. 82, which can be relied upon until Treas. Reg. 1.45D-1 is revised.

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A "targeted population" means individuals or an identifiable group of individuals, including an Indian tribe, who are low-income persons or otherwise lack adequate access to loans or equity investments. The term "low-income" means having an income, adjusted for family size, of not more than:

• 1. For metropolitan areas, 80% of the area median family income.

• 2. For non-metropolitan areas, the greater of 80% of the area median family income or 80% of the statewide nonmetropolitan area median family income.

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A “targeted population” includes individuals in the Hurricane Katrina Gulf Opportunity (GO) Zone if the individual was displaced from his or her principal residence as a result of Hurricane Katrina and/or the individual lost his or her principal source of employment as a result of Hurricane Katrina. In order to meet this definition, the individual's principal residence or principal source of employment must have been located in a population census tract within the GO Zone that contains one or more areas designated by FEMA as flooded, having sustained extensive damage, or having sustained catastrophic damage as a result of Hurricane Katrina.

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Time of Investment in a Low-Income Community
Under Treas. Reg. §1.45D-1(c)(5)(iv), the CDE’s investments in low-income communities must be made within 12 months of receiving the taxpayer’s cash investment beginning on the date the cash is paid by the taxpayer (directly or through an underwriter).

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Special Rules for Loans
Periodic amounts received during a calendar year as repayment of principal on a loan that is a QLICI are treated as continuously invested in a QLICI if reinvested by the end of the following year. See Treas. Reg. §1.45D-1(d)(2)(iii).
 

Special Rule for Reserves

• Reserves (not more than 5% of the taxpayer’s cash investment) maintained by the CDE for loan losses or for additional investments in existing low-income community investments are treated as invested in a qualified low-income community investment.

• Reserves include fees paid to third parties to protect against loss of all or a portion of the principal of, or interest on, a loan. See Treas. Reg. §1.45D-1(d)(3). 

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Loans Must Be Bona Fide Debt
Under IRC §45D(d)(2), a QLICI includes any loan to a qualified active low-income business (QALICB). Therefore, the loan documents should be reviewed to determine whether the loan is bona fide debt. Supporting documents also include, but are not limited to, appraisal reports, historical and forecasted statements of operations and cash flows, and guarantee agreements and balance sheets for guarantors.

• Notice 94-47, 1994-1 C.B. 357, provides that the characterization of an instrument for federal income tax purposes depends on the terms of the instrument and all the surrounding facts and circumstances. Factors that may be considered include:

  • ​1. whether there is an unconditional promise on the part of the QALICB to pay a fixed sum on demand or at a fixed maturity date that is in the reasonable foreseeable future,

  • 2. whether the CDE has the right to enforce the payment of principal and interest,

  • 3. whether the CDE’s rights are subordinate to rights of general creditors,

  • 4. whether the instruments give the CDE the right to participate in the management of the QALICB,

  • 5. whether the QALICB is thinly capitalized,

  • 6. whether the stockholders or partners of the CDE are related to the QALICB’s owners,

  • 7. the label placed upon the instrument by the parties, and

  • 8. whether the instrument is intended to be treated as debt or equity for non-tax purposes, including regulatory, rating agency, or financial accounting purposes. 

• See also Goldstein v. Commissioner, T.C. Memo 1980-273, 40 TCM 752 (1980), among the common factors considered when making this determination as noted below.

  • ​1. a note or other evidence of indebtedness exists,

  • 2. interest is charged,

  • 3. there is a fixed schedule for repayments,

  • 4. any security or collateral is requested,

  • 5. there is any written loan agreement,

  • 6. a demand for repayment has been made,

  • 7. the parties' records, if any, reflect the transaction as a loan

  • 8. any repayments have been made, and

  • 9. the borrower was solvent at the time of the loan. 

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Amount Paid at Original Issue
Under IRC §45D(b)(1)(A) and Treas. Reg. §1.45D-1(b)(4), the amount paid by the investor to the CDE for a QEI at its original issue consists of all amounts paid by the taxpayer to, or on behalf of, the CDE and includes any underwriter fees to purchase the investment at its original issue.

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Time of Investment

• In general, an equity investment in a CDE is not eligible to be designated as a QEI if it is made before the CDE enters into an allocation agreement with the Community

• Development Financial Institutions Fund (CDFI). The allocation agreement specifies the terms of the NMTC allocation under IRC §45D(f)(2). However, for exceptions to the rule, see Treas. Reg. §1.45D-1(c)(3)(ii).

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Reporting Requirements
A CDE must provide notice to any investor who acquires a QEI in the CDE at its original issue that the equity investment is a QEI entitling the investor to claim the NMTC. The notice is made using Form 8874-A, Notice of Qualified Equity Investment for New Markets Credit, or for periods before March 2007, a written notification prepared by the CDE. The notice must be provided by the CDE to the taxpayer no later than 60 days after the date the investor makes the equity investment in the CDE. The notice must contain the amount paid to the CDE for the QEI at its original issue and the CDE’s taxpayer identification number. (Treas. Reg. §1.45D-1(g)(2)(A).)

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Allocation Limitation
The amount of QEIs designated by a CDE may not exceed the amount allocated to the CDE by the CDFI Fund. The term QEI does not include:

• Any equity investment issued by a CDE more than 5 years after the CDE enters into an allocation agreement with the CDFI Fund, and

• Any equity investment by a CDE in another CDE, if the CDE making the investment has received an allocation under IRC §45D(f)(2). This prevents a CDE with an allocation from investing in another CDE with an allocation, and thereby doubling up credits on a single investment. 

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Allowance of Credit

The NMTC is included under IRC §38(a)(13) as part of the General Business Credit. The credit equals 39% of the investment and is claimed during a seven-year credit period. Investors may not redeem or otherwise cash out their investments in the CDEs prior to the conclusion of the seven-year credit period.

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Credit Allowance Date
A taxpayer holding a qualified equity investment (QEI) on a credit allowance date occurring during the taxable year may claim the NMTC for such taxable year in an amount equal to the applicable percentage of the amount paid to a qualified community development entity (CDE) for such investment at its original issue.

Under IRC §45D(a)(3), the term credit allowance date means, with respect to any QEI:

• 1. The date on which the investment is initially made; and

• 2. Each of the six anniversary dates of such date thereafter.

 

In other words, the credit period is the seven-year period beginning on the date a QEI is initially made, even though the credit is allowable on the first day of each credit year.

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Applicable Percentage
The credit provided to the investor equals 39% of the QEI and is claimed over the seven-year credit period. Under IRC §45D(a)(2), the applicable percentage is 5 percent for the first three credit allowance dates and 6 percent for the last four credit allowance dates. 

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In essence, an investor in the NMTC program gets 39 cents in tax credits during the seven-year credit period for every dollar invested and designated as a QEI.

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Manner of Claiming the New Markets Tax Credit
A taxpayer may claim the NMTC for each applicable year by completing Form 8874, New Markets Credit, and filing the form with the taxpayer’s federal income tax return.

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Subsequent Purchasers
Under Treas. Reg. §1.45D-1(c)(7), a QEI includes any equity investment that would be a QEI in the hands of the taxpayer (but for the requirement that the investment be acquired by the taxpayer at its original issue) if the investment was a QEI in the hands of a prior holder.

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Credit Recapture
If, at any time during the 7 years beginning on the date of the original issue of a QEI in a CDE, there is a recapture event with respect to the investment, then the tax imposed for the taxable year in which the recapture event occurs is increased by the credit recapture amount. A recapture event requires recapture of credits allowed to the taxpayer who purchased the equity investment from the CDE at its original issue and to all subsequent holders of that investment.

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Under IRC §45D(g)(3), there is a recapture event with respect to any equity investment in a CDE if one of the following three events occurs:

• 1. The CDE ceases to be a CDE,

• 2. The taxpayer’s investment ceases to meet the substantially-all requirement, which involves investments in qualified low-income community investments (QLICIs), or

• 3. The investment is redeemed or otherwise cashed out by the CDE.

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Relationship to Other Federal Tax Benefits

The availability of other federal tax benefits does not limit the availability of the NMTC. Under Treas. Reg, §1.45D-1(g)(3), examples include:

• 1. The Rehabilitation Credit under IRC §47. 

• 2. All deductions under IRC §§167 and 168, including first year depreciation under IRC §168(k), and the expense deduction for certain depreciable property under IRC §179.

• 3. All tax benefits relating to certain designated areas such as empowerment zones and enterprise communities under IRC §1391 through IRC §1397D, the District of Columbia Enterprise Zone under IRC §1400 through IRC §1400B, renewal communities under IRC §1400E through IRC §1400J, and the New York Liberty Zone under IRC §1400L.

• 4. A CDE is not prohibited from purchasing tax-exempt bonds because tax-exempt financing provides a subsidy to borrowers and not bondholders. See T.D. 9171, 69 FR 77627, for discussion of Tax Exempt Bonds under IRC §103.
   

Exception for Low-Income Housing Credit
If a CDE makes a capital or equity investment or a loan with respect to a qualified low-income building under IRC §42, the investment or loan is not a QLICI to the extent the building’s eligible basis under IRC §42(d) is financed by the proceeds of the investment or loan. See Treas. Reg. §1.45D-1(g)(3)(C)(ii).

 

Anti-Abuse Rules

If a principal purpose of a transaction, or a series or transactions, is to achieve a result that is inconsistent with the purpose of IRC §45D and the regulations thereunder, the Commissioner may treat the transaction or series of transactions as causing a recapture event. See IRC §45D(i)(1) and Treas. Reg. §1.45D-1(g)(1).

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Qualified Community Development Entity (CDE)

Qualified Community Development Entity (CDE) Defined
Under IRC §45D(c)(1), a CDE is any domestic corporation or partnership:

• 1. Whose primary mission is serving or providing investment capital for low-income communities or low-income persons,

• 2. That maintains accountability to residents of low-income communities through their representation on any governing board or advisory board of the CDE, and

• 3. Has been certified as a CDE by the CDFI Fund. See www.cdfifund.gov for more information.

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Under IRC §45D(c)(2), any specialized small business investment company as defined in IRC §1044(c)(3) and CDFI as defined in §103 of the Community Development Banking and Financial Institutions Act of 1994 are treated as having met these requirements.

 

A CDE certification lasts for the life of the organization unless it is revoked or terminated by the CDFI Fund. To maintain its CDE certification, a CDE must certify annually during this period that the CDE has continued to meet the CDE certification requirements. 

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Both for-profit and non-profit CDEs may apply to the CDFI Fund for an allocation of NMTC, but only a for-profit CDE is permitted to provide the NMTC to its investors. Thus, if a non-profit CDE receives an allocation of NMTC, it must “suballocate” its NMTC allocation to one or more for-profit CDEs.

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Qualified Low Income Community Investments (QLICI)
The investor’s cash investment received by a CDE is treated as invested in a QLICI only to the extent that the cash is so invested no later than 12 months after the date the cash is paid by the investor (directly or through an underwriter) to the CDE. The cash investment can be one of the four following types of QLICIs under IRC §45D(d)(1):

• 1. Any capital or equity investment in, or loan to, any qualified active low-income community business.

• 2. A loan purchased by a CDE from another CDE which is a QLICI.

• 3. Financial counseling and other services to any qualified active low-income community business, or to any residents of a low-income community.

• 4. Any equity investment in, or loan to, other CDEs. See Treas. Reg. §1.45D1(d)(1)(iv).

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IRS Links, Notices, & Filing Requirements​

• About Form 8874, New Markets Credit

• About Form 8874-A, Notice of Qualified Equity Investment for New Markets Credit

• About Form 8874-B, Notice of Recapture Event for New Markets Credit

• New Markets Tax Credit (IRS Background Summary)

• Notice 2006-60, Section 45D.—New Markets Tax Credit

• NEW MARKETS TAX CREDIT PROGRAM, U.S. Department of the Treasury, Community Development Financial Institutions Fund