[Federal Register Volume 69, Number 48 (Thursday, March 11, 2004)]
[Rules and Regulations]
[Pages 11507-11512]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-5560]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9116]
RIN 1545-BC02


New Markets Tax Credit Amendments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document contains amendments to temporary regulations for 
the new markets tax credit under section 45D. The regulations revise 
and clarify certain aspects of those regulations and affect a taxpayer 
making a qualified equity investment in a qualified community 
development entity that has received a new markets tax credit 
allocation. The text of these temporary regulations also serves as the 
text of the proposed regulations set forth in the notice of proposed 
rulemaking on this subject in the Proposed Rules section in this issue 
of the Federal Register.

DATES: Effective Date: These regulations are effective March 11, 2004.
    Applicability Date: For date of applicability, see Sec.  1.45D-
1T(h).

FOR FURTHER INFORMATION CONTACT: Paul F. Handleman or Lauren R. Taylor, 
(202) 622-3040 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document amends 26 CFR part 1 to provide amended rules (the 
revised regulations) relating to the new markets tax credit under 
section 45D of the Internal Revenue Code (Code). On December 26, 2001, 
the IRS published temporary and proposed regulations (the 2001 
temporary regulations) in the Federal Register (66 FR 66307, 66 FR 
66376). Written and electronic comments responding to the 2001 
temporary regulations were received. The IRS and Treasury Department 
have reviewed the comments on the 2001 temporary regulations and 
decided to revise and clarify certain aspects of those regulations. The 
IRS and Treasury Department continue to consider comments on the 2001 
temporary regulations that are not addressed in the revised 
regulations.

Explanation of Provisions

General Overview

    Taxpayers may claim a new markets tax credit on a credit allowance 
date in an amount equal to the applicable percentage of the taxpayer's 
qualified equity investment in a qualified community development entity 
(CDE). The credit allowance date for any qualified equity investment is 
the date on which the investment is initially made and each of the 6 
anniversary dates thereafter. The applicable percentage is 5 percent 
for the first 3 credit allowance dates and 6 percent for the remaining 
credit allowance dates.
    A CDE is any domestic corporation or partnership if: (1) The 
primary mission of the entity is serving or providing investment 
capital for low-income communities or low-income persons; (2) the 
entity maintains accountability to residents of low-income communities 
through their representation on any governing board of the entity or on 
any advisory board to the entity; and (3) the entity is certified by 
the Secretary for purposes of section 45D as being a CDE.
    The new markets tax credit may be claimed only for a qualified 
equity investment in a CDE. A qualified equity investment is any equity 
investment in a CDE for which the CDE has received an allocation from 
the Secretary if, among other things, the CDE uses substantially all of 
the cash from the investment to make qualified low-income community 
investments. Under a safe harbor, the substantially-all requirement is 
treated as met if at least 85 percent of the aggregate gross assets of 
the CDE are invested in qualified low-income community investments.
    Qualified low-income community investments consist of: (1) Any 
capital or equity investment in, or loan to, any qualified active low-
income community business; (2) the purchase from another CDE of any 
loan made by such entity that is a qualified low-income community 
investment; (3) financial counseling and other services to businesses 
located in, and residents of, low-income communities; and (4) certain 
equity investments in, or loans to, a CDE.
    In general, a qualified active low-income community business is a 
corporation or a partnership if for the taxable year: (1) At least 50 
percent of the total gross income of the entity is derived from the 
active conduct of a qualified business within any low-income community; 
(2) a substantial portion of the use of the tangible property of the 
entity is within any low-income community; (3) a substantial portion of 
the services performed for the entity by its employees is performed in 
any low-income community; (4) less than 5 percent of the average of the 
aggregate unadjusted bases of the property of the entity is 
attributable to certain collectibles; and (5) less than 5 percent of 
the average of the aggregate unadjusted bases of the property of the 
entity is attributable to certain nonqualified financial property.

Substantially All

    As indicated above, a CDE must use substantially all of the cash 
from a qualified equity investment to make qualified low-income 
community investments. Section 1.45D-1T(c)(5)(i) provides that the 
substantially-all requirement is treated as satisfied for an annual 
period if either the direct-tracing calculation under Sec.  1.45D-
1T(c)(5)(ii), or the safe harbor calculation under Sec.  1.45D-
1T(c)(5)(iii), is performed every six months and the average of the two 
calculations for the annual period is at least 85 percent. Commentators 
have suggested that the use of the direct-tracing calculation (or the 
safe harbor calculation) for an annual period should not preclude the 
use of the safe harbor calculation (or the direct-tracing calculation) 
for another annual period. The revised regulations adopt this 
suggestion.
    Commentators have suggested that, if a CDE makes a qualified low-
income community investment from a source of funds other than a 
qualified equity investment (for example, a line of credit from a 
bank), and later uses proceeds of an equity investment in the CDE to 
reimburse or repay the other source of funds, the equity investment 
should be treated as financing the qualified low-income community 
investment on a direct-tracing basis. The revised regulations do not 
adopt this suggestion because, in these circumstances, the proceeds of 
the equity investment are not ``used . . . to make'' the qualified low-
income community investment as required by section 45D(b)(1)(B). 
However, the revised regulations provide an example demonstrating that, 
in this situation, the substantially-all requirement may be satisfied 
under the safe harbor calculation.

Qualified Low-Income Community Investments

    Under section 45D(d)(1)(B), a qualified low-income community

[[Page 11508]]

investment includes the purchase from another CDE of any loan made by 
such entity that is a qualified low-income community investment. 
Commentators have suggested that, for purposes of section 45D(d)(1)(B), 
a loan by an entity should be treated as made by a CDE, even if the 
entity is not a CDE at the time it makes the loan, so long as the 
entity is a CDE at the time it sells the loan. The revised regulations 
adopt this suggestion, in accordance with Notice 2003-68 (2003-41 
I.R.B. 824).
    Commentators also have suggested that the phrase ``made by such 
entity'' for purposes of section 45D(d)(1)(B) should include any loans 
held or purchased by such entity. The revised regulations do not adopt 
this suggestion because it would treat loan purchases as qualified low-
income community investments even if the originator or a prior seller 
of the loan were not a CDE. However, the revised regulations do contain 
a special rule, as set forth in Notice 2003-68, that applies to the 
purchase of a loan by a CDE (the ultimate CDE) from a second CDE if the 
loan was made by a third CDE (the originating CDE). Specifically, the 
revised regulations provide that, for purposes of section 45D(d)(1)(B): 
(1) The purchase of a loan by the ultimate CDE from a second CDE that 
purchased the loan from the originating CDE (or from another CDE) is 
treated as a purchase of the loan by the ultimate CDE from the 
originating CDE, provided that each entity that sold the loan was a CDE 
at the time it sold the loan; and (2) a loan purchased by the ultimate 
CDE from another CDE is a qualified low-income community investment if 
it qualifies as a qualified low-income community investment either (A) 
at the time the loan was made or (B) at the time the ultimate CDE 
purchases the loan.
    Commentators have suggested that, in certain circumstances in which 
a CDE purchases a loan from another entity under an advance commitment 
agreement, the loan should be treated as made by the CDE and therefore 
eligible to be a qualified low-income community investment. The revised 
regulations provide that, for these purposes, a loan is treated as made 
by a CDE to the extent the CDE purchases the loan from the originator 
(whether or not the originator is a CDE) within 30 days after the date 
the originator makes the loan if, at the time the loan is made, there 
is a legally enforceable written agreement between the originator and 
the CDE which (A) requires the CDE to approve the making of the loan 
either directly or by imposing specific written loan underwriting 
criteria and (B) requires the CDE to purchase the loan within 30 days 
after the date the loan is made.
    Section 1.45D-1T(d)(1)(iv) provides that a qualified low-income 
community investment includes an equity investment in, or loan to, 
another CDE, but only to the extent that the recipient CDE uses the 
proceeds: (1) for either an investment in, or a loan to, a qualified 
active low-income community business, or financial counseling and other 
services; and (2) in a manner that would constitute a qualified low-
income community investment if it were made directly by the CDE making 
the equity investment or loan. Commentators have suggested that this 
provision should be amended to permit investments through multiple 
tiers of CDEs. For example, commentators have indicated that some CDEs 
have reasons relating to bank regulatory requirements for lending to 
bank holding company CDEs that invest in bank subsidiary CDEs. The 
revised regulations amend this provision, in accordance with Notice 
2003-64 (2003-39 I.R.B. 646), to permit investments through two 
additional CDEs.

Qualified Active Low-Income Community Business

    Section 45D(d)(2)(A)(i) provides that a corporation (including a 
nonprofit corporation) or a partnership is a qualified active low-
income community business only if, among other things, at least 50 
percent of the total gross income of the entity is derived from the 
active conduct of a qualified business within any low-income community. 
Commentators have requested clarification of the meaning of ``active 
conduct''. Some commentators have suggested that the term should 
include start-up businesses, including the development of commercial 
rental property. Other commentators have suggested defining active 
conduct by focusing on the economic effect of a particular business 
activity. The revised regulations provide a special rule that makes 
clear that an entity will be treated as engaged in the active conduct 
of a trade or business if, at the time the CDE makes a capital or 
equity investment in, or loan to, the entity, the CDE reasonably 
expects that the entity will generate revenues (or, in the case of a 
nonprofit corporation, receive donations) within 3 years after the date 
the investment or loan is made.
    Section 45D(d)(2)(A)(iii) provides that a corporation or a 
partnership is a qualified active low-income community business only 
if, among other things, a substantial portion of the services performed 
for such entity by its employees are performed in a low-income 
community (the services test). Section 1.45D-1T(d)(4)(i)(C) defines 
substantial portion for this purpose as 40 percent. Commentators have 
requested guidance on compliance with the services test if an entity 
has no employees. One commentator has suggested that, if the entity is 
a partnership and has no employees, the test should be applied to the 
general partners or managing members. The revised regulations provide 
that, if an entity has no employees, the entity is deemed to satisfy 
the services test (as well as the requirement in Sec.  1.45D-
1T(d)(4)(i)(A) that at least 50 percent of the total gross income of 
the entity be derived from the active conduct of a qualified business 
within a low-income community) if at least 85 percent of the use of the 
tangible property of the entity (whether owned or leased) is within a 
low-income community.

Control

    Under Sec.  1.45D-1T(d)(6)(i), an entity is treated as a qualified 
active low-income community business if the CDE reasonably expects, at 
the time the CDE makes the capital or equity investment in, or loan to, 
the entity, that the entity will satisfy the requirements to be a 
qualified active low-income community business throughout the entire 
period of the investment or loan. However, under Sec.  1.45D-
1T(d)(6)(ii)(A), if the CDE controls or obtains control of the entity 
at any time during the 7-year credit period, the entity will be treated 
as a qualified active low-income community business only if the entity 
satisfies the applicable requirements throughout the entire period the 
CDE controls the entity. Section 1.45D-1T(d)(6)(ii)(B) generally 
defines control with respect to an entity as direct or indirect 
ownership (based on value) or control (based on voting or management 
rights) of 33 percent or more of the entity. Commentators have 
suggested that this definition should be revised to increase the 
threshold for control. The revised regulations amend the definition of 
control to mean direct or indirect ownership (based on value) or 
control (based on voting or management rights) of more than 50 percent 
of the entity.
    Commentators have suggested that if a CDE obtains control of an 
entity subsequent to making an investment in the entity, the CDE should 
be granted a reasonable period (such as 12 months) either to cause the 
entity to satisfy the requirements to be a qualified active low-income 
community business or to find a replacement investment. The revised 
regulations provide a 12-month period during which a CDE's acquisition 
of control of an entity is disregarded if, among other things, the 
CDE's

[[Page 11509]]

investment in the entity met the reasonable expectations test of Sec.  
1.45D-1T(d)(6)(i) when initially made and the acquisition of control is 
due to unforeseen financial difficulties of the entity.

Other Issues

    Commentators have suggested that taxpayers should be able to claim 
the new markets tax credit in the event the CDE in which the qualified 
equity investment is made becomes bankrupt. The revised regulations 
adopt this suggestion.
    The revised regulations incorporate Notice 2003-9 (2003-5 I.R.B. 
369), which permits certain equity investments made on or after April 
20, 2001, to be designated as qualified equity investments, and Notice 
2003-56 (2003-34 I.R.B. 396), which permits certain equity investments 
made on or after the date the Treasury Department publishes a Notice of 
Allocation Availability to be designated as qualified equity 
investments. The revised regulations also incorporate Notice 2002-64 
(2002-41 I.R.B. 690), which provides guidance on Federal tax benefits 
that do not limit the availability of the new markets tax credit. The 
IRS and Treasury Department continue to study how the low-income 
housing credit under section 42 may limit the availability of the new 
markets tax credit.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For 
applicability of the Regulatory Flexibility Act (5 U.S.C. 601 et seq.), 
refer to the cross-reference notice of proposed rulemaking published 
elsewhere in this issue of the Federal Register. Pursuant to section 
7805(f) of the Code, these amendments to the 2001 temporary regulations 
will be submitted to the Chief Counsel for Advocacy of the Small 
Business Administration for comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Paul F. Handleman, 
Office of the Associate Chief Counsel (Passthroughs and Special 
Industries), IRS. However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.45D-1T is amended by:
0
1. Revising the section heading.
0
2. Amending paragraph (a) by:
    (a) Amending the entry for (c)(3)(ii) by removing the word 
``Exception'' and by adding the word ``Exceptions'' in its place.
    (b) Adding new entries for (c)(3)(ii)(A) and (B).
    (c) Redesignating the entry for (c)(3)(iii) as (c)(3)(iv).
    (d) Adding a new entry for (c)(3)(iii).
    (e) Adding a new entry for (c)(5)(vi).
    (f) Adding new entries for (d)(1)(ii)(A), (d)(1)(ii)(B), 
(d)(1)(ii)(C), and (d)(1)(ii)(D).
    (g) Adding new entries for (d)(1)(iv)(A) and (d)(1)(iv)(B).
    (h) Adding new entries for (d)(4)(iv), (d)(4)(iv)(A), and 
(d)(4)(iv)(B).
    (i) Adding a new entry for (d)(6)(ii)(C).
    (j) Adding new entries for (d)(8), (d)(8)(i), and (d)(8)(ii).
    (k) Adding new entries for (g)(3), (g)(3)(i), (g)(3)(ii), and 
(g)(4)
    (l) Amending the entry for (h) by removing the word ``Date'' and by 
adding the word ``Dates'' in its place.
    (m) Adding new entries for (h)(1) and (h)(2).

0
3. Amending paragraph (c)(3)(ii) by removing the word ``Exception'' and 
by adding the word ``Exceptions'' in its place.

0
4. Revising paragraphs (c)(3)(ii)(A) and (c)(3)(ii)(B).

0
5. Removing paragraph (c)(3)(ii)(C) and (c)(3)(ii)(D).

0
6. Redesignating paragraph (c)(3)(iii) as paragraph (c)(3)(iv).

0
7. Adding a new paragraph (c)(3)(iii), a sentence after the third 
sentence in paragraph (c)(5)(i), a new paragraph (c)(5)(vi).

0
8. Revising paragraphs (d)(1)(ii) and (iv).

0
9. Adding a sentence at the end of paragraph (d)(4)(i)(A), a sentence 
at the end of paragraph (d)(4)(i)(C), a new paragraph (d)(4)(iv).

0
10. Revising paragraph (d)(6)(ii)(B)

0
11. Adding new paragraph (d)(6)(ii)(C), a new paragraph (d)(8), new 
paragraphs (g)(3) and (g)(4).

0
12. Revising paragraph (h).
    The additions and revisions read as follows:


Sec.  1.45D-1T  New markets tax credit (temporary).

    (a) * * *
* * * * *
    (c) * * *
    (3) * * *
    (ii) Exceptions.
    (A) Allocation applications submitted by August 29, 2002.
    (B) Other allocation applications.
    (iii) Failure to receive allocation.
    (iv) Initial investment date.
* * * * *
    (5) * * *
    (vi) Examples.
* * * * *
    (d) * * *
    (1) * * *
    (ii) * * *
    (A) In general.
    (B) Certain loans made before CDE certification.
    (C) Intermediary CDEs.
    (D) Examples.
* * * * *
    (iv) * * *
    (A) In general.
    (B) Examples.
* * * * *
    (4) * * *
    (iv) Active conduct of a trade or business.
    (A) Special rule.
    (B) Example.
* * * * *
    (6) * * *
* * * * *
    (ii) * * *
* * * * *
    (C) Disregard of control.
* * * * *
    (8) Special rule for certain loans.
    (i) In general.
    (ii) Example.
* * * * *
    (g) * * *
    (3) Other Federal tax benefits.
    (i) In general.
    (ii) Low-income housing credit.
    (4) Bankruptcy of CDE.
    (h) Effective dates.
    (1) In general.
    (2) Exception for certain provisions.
* * * * *
    (c) * * *
    (3) * * *
    (ii) Exceptions. * * *
    (A) Allocation applications submitted by August 29, 2002.
    (1) The equity investment is made on or after April 20, 2001;
    (2) The designation of the equity investment as a qualified equity 
investment is made for a credit

[[Page 11510]]

allocation received pursuant to an allocation application submitted to 
the Secretary no later than August 29, 2002; and
    (3) The equity investment otherwise satisfies the requirements of 
section 45D and this section; or
    (B) Other allocation applications.
    (1) The equity investment is made on or after the date the 
Secretary publishes a Notice of Allocation Availability (NOAA) in the 
Federal Register;
    (2) The designation of the equity investment as a qualified equity 
investment is made for a credit allocation received pursuant to an 
allocation application submitted to the Secretary under that NOAA; and
    (3) The equity investment otherwise satisfies the requirements of 
section 45D and this section.
    (iii) Failure to receive allocation. For purposes of paragraph 
(c)(3)(ii)(A) of this section, if the entity in which the equity 
investment is made does not receive an allocation pursuant to an 
allocation application submitted no later than August 29, 2002, the 
equity investment will not be eligible to be designated as a qualified 
equity investment. For purposes of paragraph (c)(3)(ii)(B) of this 
section, if the entity in which the equity investment is made does not 
receive an allocation under the NOAA described in paragraph 
(c)(3)(ii)(B)(1) of this section, the equity investment will not be 
eligible to be designated as a qualified equity investment.
* * * * *
    (5) * * *
    (i) * * * The use of the direct-tracing calculation under paragraph 
(c)(5)(ii) of this section (or the safe harbor calculation under 
paragraph (c)(5)(iii) of this section) for an annual period does not 
preclude the use of the safe harbor calculation under paragraph 
(c)(5)(iii) of this section (or the direct-tracing calculation under 
paragraph (c)(5)(ii) of this section) for another annual period. * * *
* * * * *

    (vi) Examples. The following examples illustrate an application of 
this paragraph (c)(5):

    Example 1. X is a partnership and a CDE that has received a $1 
million new markets tax credit allocation from the Secretary. On 
September 1, 2004, X uses a line of credit from a bank to fund a $1 
million loan to Y. The loan is a qualified low-income community 
investment under paragraph (d)(1) of this section. On September 5, 
2004, A pays $1 million to acquire a capital interest in X. X uses 
the proceeds of A's equity investment to pay off the $1 million line 
of credit that was used to fund the loan to Y. X's aggregate gross 
assets consist of the $1 million loan to Y and $100,000 in other 
assets. A's equity investment in X does not satisfy the 
substantially-all requirement under paragraph (c)(5)(i) of this 
section using the direct-tracing calculation under paragraph 
(c)(5)(ii) of this section because the cash from A's equity 
investment is not used to make X's loan to Y. However, A's equity 
investment in X satisfies the substantially-all requirement using 
the safe harbor calculation under paragraph (c)(5)(iii) of this 
section because at least 85 percent of X's aggregate gross assets 
are invested in qualified low-income community investments.
    Example 2. X is a partnership and a CDE that has received a new 
markets tax credit allocation from the Secretary. On August 1, 2004, 
A pays $100,000 for a capital interest in X. On August 5, 2004, X 
uses the proceeds of A's equity investment to make an equity 
investment in Y. X controls Y within the meaning of paragraph 
(d)(6)(ii)(B) of this section. For the annual period ending July 31, 
2005, Y is a qualified active low-income community business (as 
defined in paragraph (d)(4) of this section). Thus, for that period, 
A's equity investment satisfies the substantially-all requirement 
under paragraph (c)(5)(i) of this section using the direct-tracing 
calculation under paragraph (c)(5)(ii) of this section. For the 
annual period ending July 31, 2006, Y no longer is a qualified 
active low-income community business. Thus, for that period, A's 
equity investment does not satisfy the substantially-all requirement 
using the direct-tracing calculation. However, during the entire 
annual period ending July 31, 2006, X's remaining assets are 
invested in qualified low-income community investments with an 
aggregate cost basis of $900,000. Consequently, for the annual 
period ending July 31, 2006, at least 85 percent of X's aggregate 
gross assets are invested in qualified low-income community 
investments. Thus, for the annual period ending July 31, 2006, A's 
equity investment satisfies the substantially-all requirement using 
the safe harbor calculation under paragraph (c)(5)(iii) of this 
section.
    Example 3. X is a partnership and a CDE that has received a new 
markets tax credit allocation from the Secretary. On August 1, 2004, 
A and B each pay $100,000 for a capital interest in X. X does not 
treat A's and B's equity investments as one qualified equity 
investment under paragraph (c)(6) of this section. On September 1, 
2004, X uses the proceeds of A's equity investment to make an equity 
investment in Y and X uses the proceeds of B's equity investment to 
make an equity investment in Z. X has no assets other than its 
investments in Y and Z. X controls Y and Z within the meaning of 
paragraph (d)(6)(ii)(B) of this section. For the annual period 
ending July 31, 2005, Y and Z are qualified active low-income 
community businesses (as defined in paragraph (d)(4) of this 
section). Thus, for the annual period ending July 31, 2005, A's and 
B's equity investments satisfy the substantially-all requirement 
under paragraph (c)(5)(i) of this section using either the direct-
tracing calculation under paragraph (c)(5)(ii) of this section or 
the safe harbor calculation under paragraph (c)(5)(iii) of this 
section. For the annual period ending July 31, 2006, Y, but not Z, 
is a qualified active low-income community business. Thus, for the 
annual period ending July 31, 2006: (1) X does not satisfy the 
substantially-all requirement using the safe harbor calculation 
under paragraph (c)(5)(iii) of this section; (2) A's equity 
investment satisfies the substantially-all requirement using the 
direct-tracing calculation because A's equity investment is directly 
traceable to Y; and (3) B's equity investment does not satisfy the 
substantially-all requirement because B's equity investment is 
traceable to Z.

* * * * *
    (d) * * *
    (1) * * *
    (ii) Purchase of certain loans from CDEs--(A) In general. The 
purchase by a CDE (the ultimate CDE) from another CDE (whether or not 
that CDE has received an allocation from the Secretary under section 
45D(f)(2)) of any loan made by such entity that is a qualified low-
income community investment. A loan purchased by the ultimate CDE from 
another CDE is a qualified low-income community investment if it 
qualifies as a qualified low-income community investment either--
    (1) At the time the loan was made; or
    (2) At the time the ultimate CDE purchases the loan.
    (B) Certain loans made before CDE certification. For purposes of 
paragraph (d)(1)(ii)(A) of this section, a loan by an entity is treated 
as made by a CDE, notwithstanding that the entity was not a CDE at the 
time it made the loan, if the entity is a CDE at the time it sells the 
loan.
    (C) Intermediary CDEs. For purposes of paragraph (d)(1)(ii)(A) of 
this section, the purchase of a loan by the ultimate CDE from a CDE 
that did not make the loan (the second CDE) is treated as a purchase of 
the loan by the ultimate CDE from the CDE that made the loan (the 
originating CDE) if--
    (1) The second CDE purchased the loan from the originating CDE (or 
from another CDE); and
    (2) Each entity that sold the loan was a CDE at the time it sold 
the loan.
    (D) Examples. The following examples illustrate an application of 
this paragraph (d)(1)(ii):

    Example 1. X is a partnership and a CDE that has received a new 
markets tax credit allocation from the Secretary. Y, a corporation, 
made a $500,000 loan to Z in 1999. In January of 2004, Y is 
certified as a CDE. On September 1, 2004, X purchases the loan from 
Y. At the time X purchases the loan, Z is a qualified active low-
income community business under paragraph (d)(4)(i) of this section. 
Accordingly, the loan purchased by X from Y is a qualified low-
income community investment under

[[Page 11511]]

paragraphs (d)(1)(ii)(A) and (B) of this section.
    Example 2. The facts are the same as in Example 1 except that on 
February 1, 2004, Y sells the loan to W and on September 1, 2004, W 
sells the loan to X. W is a CDE. Under paragraph (d)(1)(ii)(C) of 
this section, X's purchase of the loan from W is treated as the 
purchase of the loan from Y. Accordingly, the loan purchased by X 
from W is a qualified low-income community investment under 
paragraphs (d)(1)(ii)(A) and (C) of this section.
    Example 3. The facts are the same as in Example 2 except that W 
is not a CDE. Because W was not a CDE at the time it sold the loan 
to X, the purchase of the loan by X from W is not a qualified low-
income community investment under paragraphs (d)(1)(ii)(A) and (C) 
of this section.

* * * * *
    (iv) Investments in other CDEs--(A) In general. Any equity 
investment in, or loan to, any CDE (the second CDE) by a CDE (the 
primary CDE), but only to the extent that the second CDE uses the 
proceeds of the investment or loan--
    (1) In a manner--
    (i) That is described in paragraph (d)(1)(i) or (iii) of this 
section; and
    (ii) That would constitute a qualified low-income community 
investment if it were made directly by the primary CDE;
    (2) To make an equity investment in, or loan to, a third CDE that 
uses such proceeds in a manner described in paragraph (d)(1)(iv)(A)(1) 
of this section; or
    (3) To make an equity investment in, or loan to, a third CDE that 
uses such proceeds to make an equity investment in, or loan to, a 
fourth CDE that uses such proceeds in a manner described in paragraph 
(d)(1)(iv)(A)(1) of this section.
    (B) Examples. The following examples illustrate an application of 
paragraph (d)(1)(iv)(A) of this section:

    Example 1. X is a partnership and a CDE that has received a new 
markets tax credit allocation from the Secretary. On September 1, 
2004, X uses $975,000 to make an equity investment in Y. Y is a 
corporation and a CDE. On October 1, 2004, Y uses $950,000 from X's 
equity investment to make a loan to Z. Z is a qualified active low-
income community business under paragraph (d)(4)(i) of this section. 
Of X's equity investment in Y, $950,000 is a qualified low-income 
community investment under paragraph (d)(1)(iv)(A)(1) of this 
section.
    Example 2. W is a partnership and a CDE that has received a new 
markets tax credit allocation from the Secretary. On September 1, 
2004, W uses $975,000 to make an equity investment in X. On October 
1, 2004, X uses $950,000 from W's equity investment to make an 
equity investment in Y. X and Y are corporations and CDEs. On 
October 5, 2004, Y uses $925,000 from X's equity investment to make 
a loan to Z. Z is a qualified active low-income community business 
under paragraph (d)(4)(i) of this section. Of W's equity investment 
in X, $925,000 is a qualified low-income community investment under 
paragraph (d)(1)(iv)(A)(2) of this section because X uses proceeds 
of W's equity investment to make an equity investment in Y, which 
uses $925,000 of the proceeds in a manner described in paragraph 
(d)(1)(iv)(A)(1) of this section.
    Example 3. U is a partnership and a CDE that has received a new 
markets tax credit allocation from the Secretary. On September 1, 
2004, U uses $975,000 to make an equity investment in V. On October 
1, 2004, V uses $950,000 from U's equity investment to make an 
equity investment in W. On October 5, 2004, W uses $925,000 from V's 
equity investment to make an equity investment in X. On November 1, 
2004, X uses $900,000 from W's equity investment to make an equity 
investment in Y. V, W, X, and Y are corporations and CDEs. On 
November 5, 2004, Y uses $875,000 from X's equity investment to make 
a loan to Z. Z is a qualified active low-income community business 
under paragraph (d)(4)(i) of this section. U's equity investment in 
V is not a qualified low-income community investment because X does 
not use proceeds of W's equity investment in a manner described in 
paragraph (d)(1)(iv)(A)(1) of this section.

* * * * *
    (4) * * *
    (i) * * *
    (A) * * * See paragraph (d)(4)(iv) of this section for 
circumstances in which an entity will be treated as engaged in the 
active conduct of a trade or business.
* * * * *
    (C) * * * If the entity has no employees, the entity is deemed to 
satisfy this paragraph (d)(4)(i)(C), and paragraph (d)(4)(i)(A) of this 
section, if the entity meets the requirement of paragraph (d)(4)(i)(B) 
of this section if ``85 percent'' is applied instead of 40 percent.
* * * * *
    (iv) Active conduct of a trade or business--(A) Special rule. For 
purposes of paragraph (d)(4)(i)(A) of this section, an entity will be 
treated as engaged in the active conduct of a trade or business if, at 
the time the CDE makes a capital or equity investment in, or loan to, 
the entity, the CDE reasonably expects that the entity will generate 
revenues (or, in the case of a nonprofit corporation, receive 
donations) within 3 years after the date the investment or loan is 
made.
    (B) Example. The application of paragraph (d)(4)(iv)(A) of this 
section is illustrated by the following example:

    Example. X is a partnership and a CDE that receives a new 
markets tax credit allocation from the Secretary on July 1, 2004. X 
makes a ten-year loan to Y. Y is a newly formed entity that will own 
and operate a shopping center to be constructed in a low-income 
community. Y has no revenues but X reasonably expects that Y will 
generate revenues beginning in December 2005. Under paragraph 
(d)(4)(iv)(A) of this section, Y is treated as engaged in the active 
conduct of a trade or business for purposes of paragraph 
(d)(4)(i)(A) of this section.

* * * * *
    (6) * * *
    (ii) * * *
    (B) Definition of control. Control means, with respect to an 
entity, direct or indirect ownership (based on value) or control (based 
on voting or management rights) of more than 50 percent of the entity.
    (C) Disregard of control. For purposes of paragraph (d)(6)(ii)(A) 
of this section, the acquisition of control of an entity by a CDE is 
disregarded during the 12-month period following such acquisition of 
control (the 12-month period) if--
    (1) The CDE's capital or equity investment in, or loan to, the 
entity met the requirements of paragraph (d)(6)(i) of this section when 
initially made;
    (2) The CDE's acquisition of control of the entity is due to 
financial difficulties of the entity that were unforeseen at the time 
the investment or loan described in paragraph (d)(6)(ii)(C)(1) of this 
section was made; and
    (3) If the acquisition of control occurs before the seventh year of 
the 7-year credit period (as defined in paragraph (c)(5)(i) of this 
section), either--
    (i) The entity satisfies the requirements of paragraph (d)(4) of 
this section by the end of the 12-month period; or
    (ii) The CDE sells or causes to be redeemed the entire amount of 
the investment or loan described in paragraph (d)(6)(ii)(C)(1) of this 
section and, by the end of the 12-month period, reinvests the amount 
received in respect of the sale or redemption in a qualified low-income 
community investment under paragraph (d)(1) of this section. For this 
purpose, the amount treated as continuously invested in a qualified 
low-income community investment is determined under paragraphs 
(d)(2)(i) and (ii) of this section.
* * * * *
    (8) Special rule for certain loans--(i) In general. For purposes of 
paragraphs (d)(1)(i), (ii), and (iv) of this section, a loan is treated 
as made by a CDE to the extent the CDE purchases the loan from the 
originator (whether or not the originator is a CDE) within 30 days 
after the date the originator makes the loan if, at the time the loan 
is made, there is a legally enforceable written agreement between the 
originator and the CDE which--
    (A) Requires the CDE to approve the making of the loan either 
directly or by

[[Page 11512]]

imposing specific written loan underwriting criteria; and
    (B) Requires the CDE to purchase the loan within 30 days after the 
date the loan is made.
    (ii) Example. The application of paragraph (d)(8)(i) of this 
section is illustrated by the following example:

    Example. (i) X is a partnership and a CDE that has received a 
new markets tax credit allocation from the Secretary. On October 1, 
2004, Y enters into a legally enforceable written agreement with W. 
Y and W are corporations but only Y is a CDE. The agreement between 
Y and W provides that Y will purchase loans (or portions thereof) 
from W within 30 days after the date the loan is made by W, and that 
Y will approve the making of the loans.
    (ii) On November 1, 2004, W makes a $825,000 loan to Z pursuant 
to the agreement between Y and W. Z is a qualified active low-income 
community business under paragraph (d)(4) of this section. On 
November 15, 2004, Y purchases the loan from W for $840,000. On 
December 31, 2004, X purchases the loan from Y for $850,000.
    (iii) Under paragraph (d)(8)(i) of this section, the loan to Z 
is treated as made by Y. Y's loan to Z is a qualified low-income 
community investment under paragraph (d)(1)(i) of this section. 
Accordingly, under paragraph (d)(1)(ii)(A) of this section, X's 
purchase of the loan from Y is a qualified low-income community 
investment in the amount of $850,000.

* * * * *
    (g) * * *
    (3) Other Federal tax benefits--(i) In general. Except as provided 
in paragraph (g)(3)(ii) of this section, the availability of Federal 
tax benefits does not limit the availability of the new markets tax 
credit. Federal tax benefits that do not limit the availability of the 
new markets tax credit include, for example:
    (A) The rehabilitation credit under section 47;
    (B) All depreciation deductions under sections 167 and 168, 
including the additional first-year depreciation under section 168(k), 
and the expense deduction for certain depreciable property under 
section 179; and
    (C) All tax benefits relating to certain designated areas such as 
empowerment zones and enterprise communities under sections 1391 
through 1397D, the District of Columbia Enterprise Zone under sections 
1400 through 1400B, renewal communities under sections 1400E through 
1400J, and the New York Liberty Zone under section 1400L.
    (ii) Low-income housing credit. This paragraph (g)(3) does not 
apply to the low-income housing credit under section 42.
    (4) Bankruptcy of CDE. The bankruptcy of a CDE does not preclude a 
taxpayer from continuing to claim the new markets tax credit on the 
remaining credit allowance dates under paragraph (b)(2) of this 
section.
    (h) Effective dates--(1) In general. Except as provided in 
paragraph (h)(2) of this section, this section applies on or after 
December 26, 2001, and expires on December 23, 2004.
    (2) Exception for certain provisions. Paragraphs (c)(3)(ii), 
(c)(3)(iii), (c)(5)(vi), (d)(1)(ii), (d)(1)(iv), (d)(4)(iv), 
(d)(6)(ii)(B), (d)(6)(ii)(C), (d)(8), (g)(3), and (g)(4) of this 
section, the fourth sentence in paragraph (c)(5)(i) of this section, 
the last sentence in paragraph (d)(4)(i)(A) of this section, and the 
last sentence in paragraph (d)(4)(i)(C) of this section apply on or 
after March 11, 2004, and may be applied by taxpayers before March 11, 
2004. The paragraphs of this section that apply before March 11, 2004 
are contained in Sec.  1.45D-1T as in effect before March 11, 2004 (see 
26 CFR part 1 revised as of April 1, 2003).

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: March 3, 2004.
Gregory F. Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-5560 Filed 3-10-04; 8:45 am]
BILLING CODE 4830-01-P