CDFA Spotlight: Tax Credits (An Overview)

Tax credits have become one of the economic development industry’s most important financing tools. As traditional funding for local economic development has continued to diminish, community leaders have had to turn elsewhere for project/business financing assistance. In the late 1990s federal funding for economic development reached an all time high with large budgets at both HUD and the EDA. Today these agencies’ budgets have been severely reduced requiring the employment of other financing techniques.

The development of tax credits and the popularity of these tools is an indirect response to the reduction of federal resources. Tax credits (sometimes called incentives) can help in a variety of ways from capitalizing new business ventures to solidifying project financing for major real estate developments. Federal and state governments have recognized the power of tax credits and incentives. With this recognition has come the development of several beneficial programs that address niche economic development needs. These programs provide a wide range of financing options including brownfields, historic rehabilitation, low-income housing, emerging markets, venture capital and a whole host of investment and job creation provisions.

As they should, tax credits do come with a considerable amount of scrutiny. Economic developers are usually measured by performance. Economic developers are paid to create jobs, improve the local economy and provide for a solid tax base for the community. When employing tax credits, the classic “but if not for argument” applies. But if not for the tax credits, the project would not attract the necessary private involvement/investment. This holds true for nearly every project provided assistance through public financing means.

Tax credits can meet many different projects and investment needs and provide for an increase on the internal rate of return for investors. They can also reduce the interest rates on a particular financing package for the project owners and most importantly, the can provide a repayment method (credits) for investors in place of cash. Tax credits can also be sold for cash in many circumstances.

Tax credits are also very flexible and can be used everywhere including urban, rural and suburban communities and in some cases on a regional basis. Tax credits also provide a targeted impact by addressing many different community sectors such as low-income areas, environmental concerns, real estate transformation, emerging markets and new/innovation industries.

Tax credit programs also bring many different stakeholders to the financing table. Credits attract investors, businesses, government entities, non-profits, community development entities, industrial development authorities, economic development corporations, financial institutions, legal entities, and the federal/state government. More importantly, and unlike other financing tools, tax credits won’t disappear during economic downturns. On the contrary, tax credit programs are very dependable and politically popular. Tax credits are politically popular because elected officials support these types of programs over traditional tax incentive deals. Tax credit programs are set up such that businesses/investors get a credit for actually committing resources to a project/business (bricks and mortar or pure cash investments). Investors must demonstrate, with written proof, that the resource commitment has been made and in turn the distributor of the tax credit is only authorized to issue credit based on actual outlays of resources. Many tax incentive programs require just a commitment of resources and in many cases these promises go unfulfilled (as is the case in many tax abatement deals).

Tax credit programs also work well in encouraging private sector leveraging of resources and acting as a catalyst for public/private partnerships. Tax credits can also help to create ‘secondary financial markets’ for sellers and buyers of credits. Bottom line…tax credits provide both primary (projects), secondary (quality of life improvements) and third tier (sellers market) benefits.

The popularity of tax credits has been slow coming due to a number of reasons. Most notably the existence of easier financing such as loans, grants, bonds, etc. Tax credits require paperwork and there is a certain amount of complexity involved in each deal. There are also a lot of misconceptions about these programs as many watchdog groups often cite them as corporate welfare. This simply is not a fair assessment of these types of tools as a user is required to show the outlay of resources to receive the benefits of tax credits. In many cities, there is a general lack of application and understanding of how tax credits can be used. The central body of knowledge and resources base for using these programs simply does not exist. Finally, the marketing of tax credit programs is highly suspect. The federal government does little to market available credits and states provide such a wide variety of programs that the marketing message can be muddled.

There are four main federal tax credit programs that have made a large impact in the economic development industry. They include:

Historic Preservation Tax Incentives
Rehabilitation tax credits were established to discourage unnecessary demolition of older buildings and to slow capital flight from older urban areas. This incentive offers a credit against total federal taxes owed, which is taken for the year in which the renovated building is put into service. The qualified rehabilitation credit is equal to 20% of renovation or construction costs, with pre-1936 buildings in non-residential income-producing use qualifying for a 10% credit. The credit is well suited to complement brownfield developments, and property tax abatements and low interest loans are the most commonly used companion incentives. >>> Learn More

Federal Brownfield Expensing Tax Incentive
This cost deduction provides a business incentive to clean up sites contaminated with hazardous substances, and is intended to offset the costs of cleanup. >>> Learn More

New Markets Tax Credits
The New Markets Tax Credit (NMTC) was created to address the lack of capital available to business and economic development ventures in low-income communities. The NMTC provides the incentive of a federal tax credit to individuals or corporations that invest in Community Development Entities (CDEs) working in targeted low-income communities. >>> Learn More

Low-Income Housing Tax Credits
Congress created the Low Income Housing Tax Credit (LIHTC) in 1986 to promote the construction and rehabilitation of housing for low-income persons. The tax credit provides a means by which developers may raise capital for the construction or acquisition and substantial rehabilitation of housing for low-income persons. Each State received an annual inflation adjusted per person allocation ($1.75 in 2003) for issuance of tax credits for qualified housing development projects. These tax credits are then used to leverage private capital into new construction or acquisition and rehabilitation of affordable housing. >>> Learn More

Every single state and the District of Columbia have state tax credit programs that address a number of different investment areas including:

- Venture capital investment
- Low-income housing
- Job creation
- Machinery and equipment
- Targeted area redevelopment
- Brownfield cleanup
- Wage adjustment credits
- Industry specific credits

The application of tax credits is becoming one of the economic development communities fastest emerging markets. CDFA has provided a number of resources online to assist with the application of these tools.

CDFA Online Resource Database – Tax Credits

CDFA Tax Credit Finance Course

This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.