Empty warehouses with cracked windows, outdated manufacturing facilities, and desolate commercial spaces: this scene is all too common in many impoverished areas in the United States. Thankfully, two federal tax incentive programs exist that are designed to improve such places by promoting private capital investment in distressed areas across the country. These two programs are the New Market Tax Credit (NMTC) Program and the Qualified Opportunity Zone (OZ) Program.
The goals of the programs are similar, working to improve economic situations in historically low-income areas. However, there are key differences when it comes to comparing the new market tax credit vs. opportunity zone programs. In this article, we’ll discuss the pros and cons of each incentive.
Pros of the New Market Tax Credit
The New Market Tax Credit incentive has generated $8 of private investment for every $1 of federal funding provided. It’s funded over 5,400 businesses and has developed 178 million square feet of manufacturing, office, and retail space. Since its beginnings in 2000, $27 billion in tax credits has been allocated to investors, halting disinvestment in communities that need economic support most. This is to say that there are many benefits happening across the nation as a result of the NMTC Program.
In addition to the obvious positive impact on communities across the nation, investors also benefit by applying the tax credit to their annual federal income taxes. The incentive allows investors a direct tax credit for seven years following an investment within a struggling community that culminates in a total tax credit on the amount invested of 39%. Investors can claim 5% of the specified investment amount every year for the initial three years. Then, they can claim 6% for each of the last four years, adding up to the seven-year 36% total tax credit.
Stipulations of the New Market Tax Credit
There are a few stipulations for the NMTC, which some investors may see as cons. Many first ask what can new market tax credits can be used for, and one potential con of the NMTC Program is that it can only be applied as a tax credit against the investors’ annual federal tax returns. It can be used in no other way.
Additionally, to qualify for the tax credits, the investment project must be designated as NMTC-eligible within a qualified census tract. The more economically distressed an area, the more likely the Community Development Entity (CDE) is to be approved to receive tax credits. Historically, the CDFI has preferred CDEs to invest in communities where poverty rates exceed 30% and the median incomes of the area are no more than 60% of the statewide median income.
Investors are required to go through a CDE to receive tax credits. All NMTC applicants must be certified as CDEs, then distribute the approved credits to the investors, meaning that a business or investor cannot directly apply for the tax credit.
Lastly, the NMTC is up for renewal yearly. This means Congress could decide to end the program. However, this is not expected in the future, as the incentive has been renewed a number of times since its inception in 2000 and has a proven track record of revitalizing low-income areas. Congress not only voted to continue the incentive in 2021, but they also increased funding for it. For many, the pros of the NMTC Program outweigh the potential cons.
Application Process for the New Market Tax Credit
The process of applying for the NMTC may vary depending on qualification and location, however, generally, it only takes five steps:
- A Community Development Entity (CDE) must be established.
- The CDE submits an NMTC Allocation Application.
- Once the application is approved, the CDE will get the tax credit allocations to provide to the investors.
- The CDE will distribute the tax allocations to private investors.
- The private investors will put their money up according to their tax credit allocation.
Differences Between the New Market Tax Credit vs. Opportunity Zone Programs
The primary difference between the new market tax credit vs. opportunity zone programs is that Congress must decide annually to renew the NMTC incentive, and it’s approved by the Treasury Department and the CDFI staff. The OZ program is a part of an International Revenue Service (IRS) rule; as such, it doesn’t have to be approved every year. Additionally, Arkansas Opportunity Zones affect capital gains on an investment, as opposed to being applied as a direct tax credit on a federal return (as the NMTC is).
Pros of the Opportunity Zone Program
In 2017, the US government developed the OZ Program to promote investments in economically disadvantaged areas. It also gave investors wondering how to invest in opportunity zones an additional avenue for wealth-building. There are 8,700 areas in the US that are designated Opportunity Zones, offering investors a number of communities to support while they generate passive income. Additionally, some Opportunity Zone tax benefits stand right now, including the following:
- Previously earned capital gains can be temporarily deferred by placing these assets in Opportunity Funds (an investment vehicle organized as a corporation or partnership for the purpose of investing in Opportunity Zone property). Those assets are not taxed until the end of 2026, or until they are no longer in the possession of the investor.
- With capital gains placed in an Opportunity Fund for at least 5 years, the investor’s basis on the original investment increases by 10%. If it is invested for at least 7 years, the amount increases by 15%.
- After 10 years, any additional appreciation on the initial investment is tax-free.
Cons of the Opportunity Zone Program
Opportunity Zones operate differently from the NMTC Program. Investments in low-income communities are inherently risky, which is, in itself, a potential con. However, there are a few other cons to consider when it comes to this government incentive:
- OZ investments are treated as capital gains; the more you gain, the more you pay in taxes.
- Only accredited investors with a net worth of $1 million who can meet specific guidelines can invest.
- The buy-ins are high, typically requiring a minimum $100K.
- The investment model is virtually untested, having only launched in 2017; without an established track record, the risk is increased.
- The program may aid in gentrification, causing the displacement of residents and businesses in Opportunity Zones.
- Some experts predict that the continual utilization of Opportunity Zone benefits could negatively impact low-income communities, as it could put the focus of generating income before the benefit of the community in question.
If you’re searching for a way to positively impact low-income communities and generate income, these types of investment opportunities could be for you. Both routes can offer incredible returns and tax breaks; however, don’t forgo the research. Fully analyzing the projects and pros and cons of the new market tax credit vs. opportunity zone programs is advisable in order to mitigate risk and make the best decision for you and the community you might impact.
Our subsidiary, Heartland Renaissance Fund, LLC (HRF) is one of the largest Arkansas-focused community development entities, as well as a multi-round recipient of the US Treasury’s New Market Tax Credit Allocation. Since 2003, we’ve received $335 million in federal allocation. We’ve monetized and invested the credits in numerous low-income communities, truly making our state a better place to live and do business.
For more information about our opportunities, contact us today at 800-216-7237, or fill out our online contact form. We look forward to making a difference with you!