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New Markets Tax Credit Presentation July 18, 2005

New Markets Tax Credit Presentation July 18, 2005. Agenda. An overview of the NMTC allocation process and the receipt of tax credits from the Treasury Dep’t. A review of a typical leveraged NMTC transaction.

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New Markets Tax Credit Presentation July 18, 2005

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  1. New Markets Tax Credit Presentation July 18, 2005

  2. Agenda • An overview of the NMTC allocation process and the receipt of tax credits from the Treasury Dep’t. • A review of a typical leveraged NMTC transaction. • A summary of the relevant NMTC requirements for a qualifying low-income community business. • A discussion of a successful NMTC transaction and its impact on the local community.

  3. Program and Background • The Basics: - Stimulate investment in businesses and commercial property in low-income communities. - Creates a tax credit for equity investments in Community Development Entities (CDEs). - NMTC investor receives a 5% federal tax credit on the qualified investment for the first 3 years and 6% for the remaining 4 years - making a total 39% credit on the investment over a 7 year period.

  4. Overview of the Credit Allocation Process • Credits are awarded on a competitive basis by the CDFI Fund of the U.S. Treasury Department. • Prior to a request for an allocation of credits from the CDFI Fund, an interested party must apply to the Treasury Department to be certified as a CDE (Community Development Entity). Only CDEs or qualified subsidiaries of CDEs can receive NMTC allocations - must apply for and receive CDE certification from CDFI. • Nationwide limits on eligible cash equity investments: 2001 - $1.0 billion; 2002 and 2003 - $1.5 billion/year;2004 and 2005 - $2.0 billion/year; 2006 and 2007 - $3.5 billion/year.

  5. NMTC Credit Allocation • Each CDE must establish a “service area” where the credits will be employed. The service area may be national, regional or state/local. • “Primarymission” test requires the CDE to provide investment capital to low-income persons or low- income communities (60% of products or services). • The CDE must establish an advisory board to ensure it maintains accountability to low income communities and properly carries out its mission. • “Accountability” test requires the CDE to remain accountable to residents of low-income communities (20% of advisory board or governing board represents interests of low-income communities). • CDE has five years to make qualified NMTC investments; unused portion of NMTC allocation returned to CDFI.

  6. “New Markets” aka Low Income Communities • The credits can only be utilized in “Low Income Communities” as defined by regulation. This includes: • Census tracts with 20% or more of the residents at the poverty rate. • Census tracts with a median family income of approximately 80% or less of the state or metropolitan area median. • Many allocatees have voluntarily agreed to deploy most of their credits in areas exhibiting additional distress criteria, such as: brownfield areas, designated Hot Zones, medically underserved areas and HUB Zones.

  7. What is a Qualified Active Low Income Community Business (QALICB) investment? • Loans or equity investments are permitted. • Business must be located in a qualified population census tract or designated area. • Purchase of qualified loans made by another CDE is a permitted investment. • The business can be organized as a corporation, partnership, LLC, sole proprietorship or even as a separate division of a larger business enterprise. • A combined commercial and residential rental project is treated as 100% commercial, (i.e., qualified, if at least 20% of gross rental income is commercial applied each taxable year).

  8. What is a Qualified Active Low Income Community Business (QALICB) investment? • Any low income community businesses may qualify except: rental of residential property or land, farms, licensing of intangibles, including golf courses, tanning salons, liquor stores and racetracks. • Five operational tests must be satisfied each taxable year for a business to qualify: • (a) 50% of gross income from active conduct of business in • low-income community; • (b) 40% of tangible property located in low-income community; • (c) 40% of wages paid for services rendered by employees in the • low-income community; • (d) less than 5% of asset cost basis in collectibles; and • (e) less than 5% of asset cost basis in passive investment assets

  9. Typical Types of Investments • Commercial real estate projects that create high impact on the low-income communities • Business expansions with high cost machinery and equipment and/or real estate additions • Community Facilities • Loans subsidized with NMTC and other resources • Working capital loans • Fixed asset loans • Expansion loans • Mortgages

  10. Examples of Actual Transactions • Manufacturer acquired a new distribution facility and purchased new manufacturing equipment kept the company in rural WI - created 50 jobs with retention of 150 jobs. • Abandoned historical industrial facility is being redeveloped into over 650,000 square feet of office and retail space and over 2,500 jobs. • 70,000 square foot expansion of an agricultural manufacturing facility with the creation of over 50 jobs.

  11. NMTC Enhanced Loan Analysis NMTC Enhanced Loan $ 5,500,000 Qualified Equity Investment Borrower Terms • 3.50% Fixed Interest Rate Interest Only (for seven years) Balloon Payment (Year 7) • $2,145,000 Lender earns in NMTC (over seven years) • Borrower’s Savings: $1,155,000 (undiscounted) Loan Without NMTC $ 5,500,000 Loan Borrower Terms • 6.50% Fixed Interest Rate

  12. Overview of the Transaction Players: • NMTC Investor • NMTC Allocatee (CDE) • Subsidiary CDE (formed by above) • Traditional Lender • Qualified Active Low Income Community Business

  13. The NMTC Investor (usually a financial institution) receives: • An offset to federal income tax liability over a 7-year period equal to 39% of a taxpayer’s cashequity investment in a CDE (equity investment can be borrowed funds). • - Investment must be issued solely for cash and must be original issue. • - Unclaimed NMTC can be claimed by any subsequent purchaser of the CDE equity interest. • - Cannot offset AMT.

  14. NMTC Recapture Events: • The NMTC will be recaptured if the equity interest in the CDE is “redeemed” within seven years. • The NMTC will be recaptured if, at any time during the 7-year recapture period, the CDE fails to satisfy the requirement that “substantially all” of its assets be invested in qualified businesses. • The “substantially all” test means, generally, that at least 85% of the CDE’s gross assets are invested in qualified businesses or other permitted investments. • Repayments of principal or equity capital from a qualified investment must be reinvested within 12 months following receipt to remain “good assets” for 85% test. • “Substantially all” test must be satisfied within 12 months of initial investment.

  15. What Makes a Fundable NMTC Project? • Community impact • Job creation and wage gains • Maintaining jobs in communities • Providing for community facilities enhancing the lives of the low-income residents • Credit provides the additional return to make the deal possible • Project is located in areas with several distress indicators • Leverage private capital • Exit strategy that is financially sound

  16. NMTC Leveraged Structure Diagram $2,781,000Equity Investment ABC Bank(New Market Tax Credit Investor) $7,219,000 Non – Recourse Loan Investment Fund, LLC XYZ Bank (Lender) $3,900,000NMTC $10,000,000 Qualified Equity Investments 99.99% Cash Flow, Profits & Losses NMTC Allocatee CDE(Sponsor, Managing Member) Certified CDE.01% - NMTC Allocatee – (Managing Member) 99.99% - ABC Bank – (Non-Managing Member) Loan Loss Reserve, Legal, & Placement Fee$500,000 $2,481,000 Loan Proceeds NMTC Interest Payments Balloon $7,219,000 Loan Proceeds Qualified Active Low Income Community Business

  17. Example NMTC Transaction Transaction Diagram City TIF Investments $2,000,000 (To be repaid) $2,725,000 (Not to be repaid) $2,000,000 Principal $2,000,000 $2,725,000 Loan $2,145.889 Capital Contribution Developer Investor. (Lender Economic Investor) Major Bank (Tax Credit Investor) Investment Fund LLC (Makes Qualified Equity Investment in CDE) $620,000 Loan $2,925.000 NMTC, 100% Cash Flow, Profits & Losses Interest Payments Interest and Balloon Payments $629,111 Loan $7,500,000 Qualified Equity Investment 99.99% Cash Flow, Profits & Losses Community Bank NMTC Tax Credit Allocatee $100 Sponsor Subsidiary CDE, LLC (Community Development Entity) .01% Sponsor Managing Member 99.99% Investment Fund LLC Investor Member Legal, Closing Fees and Other Costs $428,000 $1,717,989 NMTC Loan $4,725,000 Loan $629,111 Loan Interest Payments Developer (Qualified Active Low Income Community Business)

  18. Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.  No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.

  19. Contact Information Bret N. Bogenschneider, Esq. Virchow Krause & Company, LLP P.O. Box 7398 Madison, WI 53707-7398 Phone: (608) 240-2384 (direct) Fax: (608) 249-8532 Email: bbogenschneider@virchowkrause.com

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