The New Markets Tax Credit works by giving an investor a 39% federal income tax credit in exchange for putting cash into a certified Community Development Entity (CDE) that then finances businesses and projects in low-income communities. The credit is not paid out in a lump sum. It pays down over a seven-year compliance period, and if the deal falls out of compliance during that window, the IRS can recapture every credit already claimed, with interest. Here is how the pieces fit together, from the investor’s check to the seven-year exit.
The 39% Credit and Its Seven-Year Schedule
An investor who makes a Qualified Equity Investment (QEI) in a certified CDE receives a nonrefundable federal income tax credit equal to 39% of the cash invested. The credit is claimed over seven years on a fixed schedule: 5% of the QEI in each of the first three years, then 6% in each of the final four years. Three years at 5% is 15%, four years at 6% is 24%, and together that is the full 39%.
On a $2 million QEI, the schedule produces $100,000 a year for the first three years and $120,000 a year for the next four, totaling $780,000 in credits.
The investor claims the annual credit on IRS Form 8874, which flows into the general business credit on Form 3800. Because the credit is nonrefundable, it can offset tax liability but will not generate a refund on its own. Unused amounts carry forward under the general business credit rules.
Before any credit can be claimed, the CDE must send the investor Form 8874-A within 60 days of the investment date. That notice designates the investment as a QEI and confirms the dollar amount. Without it, there is no basis for claiming the credit.
Why a Community Development Entity Sits in the Middle
Investors do not put money directly into a local business or building. Every NMTC dollar passes through a CDE, a domestic corporation or partnership certified by the U.S. Treasury Department’s CDFI Fund. Certification requires the entity to demonstrate a primary mission of serving low-income communities and to maintain accountability through community representation on its governing board.
A certified CDE then competes for an allocation of tax credit authority. Winning an allocation is not a cash grant. It is permission to raise a specified amount of investor equity that will carry the 39% credit. The CDE solicits QEIs, receives the cash, and deploys it as loans or equity into qualifying projects, typically on below-market terms.
The statute requires that “substantially all” of the investor cash be used for Qualified Low-Income Community Investments. A safe harbor treats the test as met when at least 85% of the CDE’s aggregate gross assets are deployed in qualifying investments. The CDE is responsible for keeping the deal compliant throughout the seven-year period, monitoring the underlying business, filing annual reports with the CDFI Fund, and avoiding structures that would trigger recapture.
Which Communities and Businesses Qualify
Both the location and the recipient business have to meet statutory tests.
Low-Income Community Tests
A census tract qualifies as a low-income community if the poverty rate is at least 20%, or if its median family income falls at or below 80% of the applicable benchmark. Outside a metropolitan area, that benchmark is the statewide median family income. Inside a metro area, the benchmark is 80% of the greater of the statewide or metro median.
Deeper distress gets priority in the allocation competition. That includes tracts with poverty above 40%, unemployment at least 2.5 times the national average, or median family income at or below 40% of the applicable area median.
Since 2004, investments serving targeted populations can also qualify even when the business sits outside a qualifying tract. A targeted population means low-income individuals or an identifiable group, including an Indian tribe, who lack adequate access to loans or equity. A business serving such a population qualifies if at least 50% of gross income comes from transactions with low-income individuals, at least 40% of employees are low-income persons, or at least 50% of ownership is held by low-income individuals.
Qualified Active Low-Income Community Business
The end recipient must be a Qualified Active Low-Income Community Business, or QALICB, for-profit or nonprofit. Three ongoing tests apply:
- At least 50% of total gross income comes from actively conducting business within a low-income community.
- At least 40% of tangible property is located within a low-income community.
- At least 40% of services performed by employees are performed within a low-income community.
Some businesses are categorically excluded regardless of location: golf courses, country clubs, massage parlors, hot tub and tanning facilities, racetracks and gambling operations, and stores whose principal business is selling alcohol for off-premises consumption. Businesses that primarily develop or hold intangible property for sale or license are also excluded. Farming operations are excluded if the assets used in farming exceed $500,000 in value. Residential rental property is generally excluded, though commercial real estate in a low-income community can qualify if it carries substantial improvements.
How the Deal Is Actually Structured
Most NMTC transactions use a leveraged structure that pushes far more capital into the project than the investor writes a check for. The investor’s equity and a leverage loan from a separate lender both flow into an investment fund. The fund makes the QEI into the CDE. The CDE lends the combined amount to the qualifying business.
In a typical deal, the investor’s cash covers roughly 25–30% of the QEI and leverage debt covers the rest. On a $10 million QEI, that might be about $2.7 million from the investor and $7.3 million from a leverage lender. The investor pays $2.7 million because the present value of $3.9 million in credits paid out over seven years, discounted for time and risk, sits in that neighborhood. After transaction costs, the project ends up with a net subsidy of roughly 20% of eligible project costs.
Those costs are real. NMTC deals carry layered legal, accounting, and financial advisory fees, and the CDFI Fund requires CDEs to disclose all direct and indirect transaction costs to the qualifying business in a standalone document before closing.
The investor side is dominated by banks and large corporations with substantial, predictable federal tax liabilities. Because the credit is nonrefundable, an investor needs enough tax owed in each of the seven years to absorb the annual credit. Individuals occasionally participate, but the deal complexity and minimum sizes skew heavily institutional.
What Triggers Recapture
If certain events happen during the seven-year compliance period, the IRS recaptures every credit the investor has claimed, with interest. Three events trigger recapture:
- The CDE loses its certification as a qualified community development entity.
- The investment stops meeting the substantially-all requirement, meaning less than 85% of gross assets remain deployed in qualifying investments.
- The QEI is redeemed or otherwise cashed out by the CDE.
The recapture amount is the sum of all prior-year credits, plus interest at the federal underpayment rate under Section 6621. That interest is not deductible. A recapture event five years into a deal can cost the investor materially more than the credits were worth, because interest runs from the due date of each earlier return where a credit was claimed.
There is a narrow correction opportunity. If the CDE drops below the 85% asset test, it has one chance to fix the failure within six months of discovering it, or when it reasonably should have discovered it. Only one correction is allowed per QEI across the entire seven years. Any lapse after that triggers recapture with no second chance.
The Seven-Year Exit
NMTC deals are built to unwind once the compliance period ends. The standard mechanism is a put option negotiated up front. After the final credit is claimed, the investor exercises the put and sells its interest in the investment fund to the project sponsor or a related party, often for a nominal price such as $1,000. From there, the project company typically repays any outstanding senior leverage debt, and the CDE assigns its loan position to the fund. What remains is usually a below-market “B note” representing the NMTC equity portion, which is then forgiven.
For-profit businesses receiving that debt forgiveness face cancellation-of-indebtedness income, which is taxable unless an exclusion applies (such as insolvency or bankruptcy). Nonprofit recipients do not have this issue.
CDEs are expected to begin the unwind at least six months before the compliance period ends. If any NMTC entities are going to be dissolved after the exit, loans and collateral need to be reassigned properly, which requires coordination among the CDE, the lender, and the business. Skip that, and collateral can end up trapped in a dormant entity.
One guardrail matters more than it looks. If the loan documents reflect a pre-arranged intention to forgive the debt at year seven, the IRS may determine the loan was never bona fide debt in the first place, which can unravel the deal retroactively. The exit needs to look like a genuine business decision at the end of the period, not a foregone conclusion written into the original paperwork.
Interaction With the Low-Income Housing Tax Credit
The NMTC can generally be combined with other federal incentives, with one important limit. If a CDE makes a loan or equity investment tied to a qualified low-income building under Section 42, that investment does not count as a Qualified Low-Income Community Investment to the extent the building’s eligible basis is financed by those proceeds. You cannot use NMTC capital to finance the same portion of a housing project that is generating Low-Income Housing Tax Credits.
Credit ordering also matters for investors juggling programs. Both the rehabilitation credit and the LIHTC apply against tax liability before the NMTC under the general business credit ordering in Section 38. An investor who ignores that ordering can find the annual NMTC credit has nothing left to offset, pushing it into carryforward.