What Are Tax Credits, CDEs, QLICIs, QALIBs?
Things you need to know in an "Opportunity Zone."
(Note: Links within this article lead to sources and further information.)
I have said before, “I don’t have a numbers brain.” I do not. Concepts like distance, length, totals, taxes — anything relating to measurement — is an ephemeral concept to me. I don’t remember phone numbers without looking at the keypad, I still have to use my fingers to calculate sometimes, and I do all my accounting on paper, by hand, so I can check and double-check, and then I take that paperwork to our accountant.
I have a word brain and Frank has a numbers brain. Now married almost (Um…) 22 years, we have what is called, “Transactive Memory.” This “shared” memory is a shared system for encoding, storing, and retrieving information. It can develop over time as couples learn each other's memory areas. For example, one partner might store information in their partner's mind and then recall it by asking.
I store dates, locations, and numbers in Frank’s head, he lets me deal with words, technology, and recipes.
Neither of us has any skills or memories relating to tax law or corporate law. Why would we?
However, tax credits have become a point of question in the community because the main funding for The 1982 Foundation is through tax credits. I suppose I had hoped someone else would figure it out, like Rare Old Bird, or, that by some miracle, someone from 1982 would be kind enough to explain them. But alas, Deirdre still has questions, and I am left still trying to understand.
It frustrates me to have to try and figure it out enough to explain it. First, because tax credits are so far outside my skill set, and second because tax credits and flows of funds really aren’t the issue for me. The core issue of my concern relates to transparency, conflict of interest, and private inurement. (See here also.)
But, even so, I’m trying to wander through the concepts of tax credits, investment funds, entities, and business types to see if I can answer some questions. Here are the core concepts I have learned so far:
What is a tax credit?
A tax credit is a dollar-for-dollar reduction of a taxpayer's bill. This can reduce the tax they owe or in some cases increase their refund amount.
Tax credits can be used for several purposes in development projects: to provide an increased internal rate of return for investors, to reduce the interest rates on a particular financing package, and perhaps most importantly, to provide a repayment method for investors in place of cash.
Investment tax credits were introduced in 1962 to protect American businesses from emerging foreign competition. Over time, though, their basic objective has changed. Today, credits are deployed more in areas of pollution control, energy conservation, green technology, and other methods of economic development.
What is an Opportunity Zone?
The area of economic development is a key factor for Calhoun County. Calhoun County is an IRS-designated “Opportunity Zone.” Opportunity Zones are an economic development tool that allows people to invest in distressed areas in the United States. Their purpose is to spur economic growth and job creation in low-income communities while providing tax benefits to investors. (See here also.)
From the IRS website:
Opportunity Zones offer tax benefits to investors who elect to temporarily defer tax on capital gains if they timely invest those gain amounts in a Qualified Opportunity Fund (QOF). Investors can defer tax on the invested gain amounts until there is an event that reduces or terminates the qualifying investment in the QOF (an "inclusion event"), or December 31, 2026, whichever is earlier.
The length of time the taxpayer holds the QOF investment determines the tax benefits they receive.
If the investor holds the QOF investment for at least five years, the basis of the QOF investment increases to 10% of the deferred gain.
If the investor holds the QOF investment for at least seven years, the basis of the QOF investment increases to 15% of the deferred gain.
If the investor holds the investment in the QOF for at least 10 years, the investor is eligible to elect to adjust the basis of the QOF investment to its fair market value on the date that the QOF investment is sold or exchanged.
I kinda-sorta understand what that means and hope you kinda-sorta do too. The point being: that as an Opportunity Zone, Calhoun is eligible for such tax credit investments.
In such Opportunity Zones, legally defined businesses, funds, and financial situations come into play.
What are Community Development Entities (CDEs)?
The federal Community Development Financial Institution (CDFI) Fund allocates tax credit authority to Community Development Entities (CDEs). CDEs are financial intermediaries through which private capital flows from an investor to a qualified business located in a low-income community. CDEs use their authority to offer tax credits to investors in exchange for equity in the CDE.
Using the capital from these equity investments, CDEs can make loans and investments to businesses operating in low-income communities on better rates and terms and more flexible features than the market. In exchange for investing in CDEs, investors claim a tax credit worth 39% of their original CDE equity stake, which is claimed over seven years.
What is Equity?
Equity can have multiple meanings, but at its core means ownership, or more specifically, the value of an ownership stake in an asset or company. Some of the most recognizable forms of equity are ownership in your home's value after subtracting your mortgage balance.
What is a Qualified Equity Investment (QEI)?
(1) In general, the term “qualified equity investment” means any equity investment in a qualified community development entity if— (A) such investment is acquired by the taxpayer at its original issue (directly or through an underwriter) solely in exchange for cash, (B) substantially all of such cash is used by the qualified community development entity to make qualified low-income community investments, and (C) such investment is designated for purposes of this section by the qualified community development entity. Such term shall not include any equity investment issued by a qualified community development entity more than 5 years after the date that such entity receives an allocation under subsection (f). Any allocation not used within such 5-year period may be reallocated by the Secretary under subsection (f). (From Cornell Law)
What is a Qualified Low Income Community Investment (QLICI)?
A Qualified Low Income Community Investment is an investment (such as a loan or equity investment) made by a Community Development Entity in a Qualified Active Low Income Community Business.
(See a list of these core terms and definitions also here.)
What is a Credit Valuation Adjustment (CVA)?
A credit valuation adjustment, in financial mathematics, is an "adjustment" to a derivative's price, as charged by a bank to a counterparty to compensate it for taking on the credit risk of that counterparty during the life of the transaction. (Wikipedia)
What’s a Qualified Rehabilitation Expenditure (QRE)?
(2) Qualified rehabilitation expenditure defined (A) In general The term “qualified rehabilitation expenditure” means any amount properly chargeable to capital account— (i) for property for which depreciation is allowable under section 168 and which is— (I) nonresidential real property, (II) residential rental property, (III) real property which has a class life of more than 12.5 years, or (IV) an addition or improvement to property described in subclause (I), (II), or (III), and (ii) in connection with the rehabilitation of a qualified rehabilitated building… (You can read the rest of this legal definition here.)
Already, my brain hurts. Does yours? But we aren’t finished rolling through the related acronyms yet.
Tax Credits for Opportunity Zones:
NMTC = New Markets Tax Credit
The NMTC Program attracts private capital into low-income communities (Opportunity Zones) by permitting individual and corporate investors to receive a tax credit against their federal income tax in exchange for making equity investments in specialized financial intermediaries called Community Development Entities (CDEs).
HTC = Historic Tax Credit, Loan, OR Housing Tax Credit, Loan.
The Historic Tax Credit (HTC) is a federal program that provides a 20% tax credit to qualified expenditures for the rehabilitation of historic buildings. The program encourages private property owners to invest in historic properties for income-producing uses, such as rental housing, offices, retail, manufacturing, and entertainment space. It can also be used to create affordable housing, including mixed-use developments. (Google AI search result text.)
HTC can also refer to a Historic Tax Credit (HTC) bridge loan, which is a loan that's secured by future tax credit equity. Lenders typically only lend up to 90–95% of the anticipated HTC equity. Bridge loans can be obtained from banks that specialize in this type of loan or from HTC investors.
HTC may also refer to the Housing Tax Credit, which is a program that provides tax credits to developers of low-income rental housing. The credits can be sold to investors to offset a portion of their federal tax liability. The value of the credits allows residences in HTC developments to be leased to qualified people at rents that are often below market rates.
Oy vey. Isn’t it wonderful how our government can create such eloquent confusion? No wonder I feel in over my head.
In an attempt to explain all this and our local situation to me, a retired CPA (Certified Public Accountant) living in Calhoun (name on file) sent me the following:
RE: Rehabilitation tax credits
Following up on prior articles on the 1982 Foundation lease and loan transactions in July 2024 for the former Calhoun High School building.
Both federal and WV tax statues permit tax credits for qualified rehabilitation expenditures “QRE” To buildings that have been designated as Historic Structures on the National Register of Historic Places. The tax credit for federal income taxes is 20% of QRE and the federal regulations are quite extensive.
The WV tax credit for state income taxes Is equal to 25% of QRE and is fully available in the year the rehabilitation is certified by the WV State Historic Officer as complete and unlike the federal credit may be sold to other WV taxpayers. The WV tax regulations are quite sparce compared to the federal regulations.
The credits are designed to incentivize rehabilitation of historic structures -- which we all should agree is a good thing. A nonprofit entity is normally not subject to income taxes and must jump through a few well-defined hoops to generate rehabilitation credits that are usable by federal tax paying entities. The credits have no value to a non-tax paying entity until it partners with a tax paying entity in some manner. The nonprofit can create a taxable subsidiary and transfer the property to be rehabilitated to that subsidiary, transferring practically all ownership to taxpaying entities.
The new taxpayer shareholders purchase their ownership interest from the nonprofit and receive the rehabilitation credits, the payments to the nonprofit are equity capital for the rehabilitation project. After a requisite holding period the nonprofit subsidiary is dissolved and the property transferred back to the nonprofit. Similar results can be achieved with long term leases from the nonprofit to a for profit lessee. Federal rules for both the creation of a taxable subsidiary or lease transaction are quite extensive.
At the end of the day there is nothing sinister regarding selling or leasing the property to be rehabilitated to a third-party tax paying entity to realize some tax related monetary value for the rehabilitation credits. The credits should be recycled back into the project as equity funding.
In that the 1982 Foundation is a public charity (See here) and the tax paying entities created are related parties, I suggest fuller disclosure of the transactions to clarify the current situation. “Sunshine is said to be the best of disinfectants.” Although not legally required at this time, transparency will help the public understand the facts.
Some of these disclosures will be required on the 2024 1982 Foundation Form 990, Schedule L:
A. Disclose owners and managing members of each of the for-profit companies and describe what the entities roles are intended to be in the transactions,
B. Disclose full copy of both leases,
C. Disclose nature and amount of any fees related to the transactions paid to related parties,
D. Disclose the discount percent required to entice tax credit investors, both Historic and New Market credit investors,
E. Disclose estimated QRE for the project excluding new facilities and buildings that are not eligible for the credit,
F. Disclose estimated annual rental costs per square foot for tenants in the building to allow timely repayment of the recent debt, and
G. Confirm the deed covenant regarding use of the “football field” was accepted by the lender.
If the 1982 Foundation rejects more or earlier disclosure, I suggest they consider retroactively reclassifying to Private Foundation status as opposed to a public charity.
I’ve printed the definitions related, as well as the CPA’s explanation and recommendations, but I admit, it might still take me some time to wrap my mind around it. A friend of mine has suggested mapping it all out on paper in a graph or flow chart like the IRS example above. Maybe I’ll try that next.