[Federal Register Volume 77, Number 189 (Friday, September 28, 2012)]
[Rules and Regulations]
[Pages 59544-59547]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-23985]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9600]
RIN 1545-BK04


New Markets Tax Credit Non-Real Estate Investments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations modifying the new 
markets tax credit program to facilitate and encourage investments in 
non-real estate businesses in low-income communities. The final 
regulations affect taxpayers claiming the new markets tax credit and 
businesses in low-income communities relying on the program.

DATES: Effective Date: These regulations are effective September 28, 
2012.
    Applicability Date: For date of applicability see Sec.  1.45D-
1(h)(4).

FOR FURTHER INFORMATION CONTACT: Julie Hanlon-Bolton, (202) 622-3040 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document amends 26 CFR part 1 to provide additional rules 
relating to the new markets tax credit under section 45D of the 
Internal Revenue Code (Code). On June 7, 2011, a notice of proposed 
rulemaking and notice of public hearing (REG-101826-11) was published 
in the Federal Register (76 FR 32882). The IRS received comments 
responding to the notice of proposed rulemaking and held a public 
hearing on September 29, 2011. After consideration of all the comments, 
the proposed regulations are adopted as amended by this Treasury 
decision. The comments are discussed in the preamble.

General Overview

    Under section 45D(a)(1), a taxpayer may claim a new markets tax 
credit on certain credit allowance dates described in section 45D(a)(3) 
over a 7-year credit period with respect to a qualified equity 
investment in a qualified community development entity (CDE) described 
in section 45D(c).
    Under section 45D(b)(1), an equity investment in a CDE is a 
qualified equity investment if, among other requirements: (A) The 
investment is acquired by the taxpayer at its original issue (directly 
or through an underwriter) solely in exchange for cash, (B) 
substantially all of the cash is used by the CDE to make qualified low-
income community investments, and (C) the investment is designated for 
purposes of section 45D by the CDE.
    Under section 45D(b)(2), the maximum amount of equity investments 
issued by a CDE that may be designated by the CDE as qualified equity 
investments shall not exceed the portion of the new markets tax credit 
limitation set forth in section 45D(f)(1) that is allocated to the CDE 
by the Secretary under section 45D(f)(2).
    Section 45D(c)(1) provides that a domestic corporation or 
partnership is a CDE if (A) the primary mission of the entity is 
serving, or providing investment capital for, low-income communities or 
low-income persons, (B) 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 (C) the entity is certified by the Secretary as a CDE.
    Section 45D(d)(1) defines qualified low-income community investment 
to mean: (A) Any capital or equity investment in, or loan to, any 
qualified active low-income community business (as defined in section 
45D(d)(2)), (B) the purchase from another CDE of any loan made by such 
entity that is a qualified low-income community investment, (C) 
financial counseling and other services specified in regulations 
prescribed by the Secretary to businesses located in, and residents of, 
low-income communities, and (D) any equity investment in, or loan to, 
any CDE.
    Under section 45D(d)(2)(A), a qualified active low-income community 
business is any corporation (including a nonprofit corporation) or 
partnership if for such year, among other requirements, (i) 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, 
(ii) a substantial portion of the use of the tangible property of the 
entity (whether owned or leased) is within any low-income community, 
and (iii) a substantial portion of the services performed for the 
entity by its employees are performed in any low-income community.

[[Page 59545]]

    Under section 45D(d)(3), with certain exceptions, a qualified 
business is any trade or business. The rental to others of real 
property located in any low-income community is a qualified business 
only if the property is not residential rental property (as defined in 
section 168(e)(2)(A)) and there are substantial improvements located on 
the real property.
    Section 1.45D-1(d)(2)(i) requires that a CDE receiving returns on 
investments (including principal repayments from amortizing loans) must 
reinvest those proceeds into other qualified low-income community 
investments during the 7-year credit period. If the proceeds are not 
reinvested, then the credit may be subject to recapture under section 
45D(g)(3)(B).
    Many commentators consider the new markets tax credit under section 
45D to be a successful tool for encouraging private sector investments 
in low-income communities. To date, the majority of new markets tax 
credit investments relate to real estate projects. Real estate projects 
are well suited to the new markets tax credit program because real 
estate remains in the low-income community and loans for real estate 
can extend through the end of the 7-year period in which investors may 
take the credit on their investment. The 7-year credit period and the 
reinvestment requirements make it difficult for CDEs to provide working 
capital and equipment loans to non-real estate businesses because these 
loans are ordinarily amortizing loans with a term of five years or 
less. To facilitate investment in non-real estate businesses, the 
proposed regulations modify the reinvestment requirements for non-real 
estate projects.

Overview of Proposed Regulations and Summary of Comments

    To encourage investments in non-real estate businesses for working 
capital and equipment, the proposed regulations modify the reinvestment 
requirements under Sec.  1.45D-1(d)(2)(i). The proposed regulations 
allow a CDE that makes a qualified low-income community investment in a 
non-real estate business to invest certain returns of capital from 
those investments in unrelated certified community development 
financial institutions that are CDEs under section 45D(c)(2)(B) 
(certified CDFIs) at various points during the 7-year credit period. 
The proposed regulations also allow an increasing aggregate amount to 
be invested in certified CDFIs and treated as continuously invested in 
a qualified low-income community investment in the later years of the 
7-year credit period.
    Many commentators welcomed new options for meeting the reinvestment 
requirements. After considering the comments received, the final 
regulations adopt the provisions of the proposed regulations with two 
minor changes based on these comments. In addition to reinvestments in 
certified CDFIs, the final regulations provide that the Secretary may 
designate other qualifying entities in the Internal Revenue Bulletin. 
These final regulations also clarify that investments in non-real 
estate qualified active low-income community businesses may be made 
through one or more CDEs. As discussed below, the IRS and the Treasury 
Department are considering other options for future guidance.

Definition of Non-Real Estate Qualified Active Low-Income Community 
Business

    The proposed regulations define a non-real estate qualified active 
low-income community business as any business whose predominant 
business activity (measured by more than 50 percent of the business' 
gross income) does not include the development (including construction 
of new facilities and rehabilitation/enhancement of existing 
facilities), management, or leasing of real estate. The purpose of the 
investment or loan must not be connected to the development (including 
construction of new facilities and rehabilitation/enhancement of 
existing facilities), management, or leasing of real estate.
    Commentators requested that the definition of a non-real estate 
qualified active low-income community business be expanded to include 
investments connected to the development of owner occupied facilities 
as long as the facility is used in an operating business. The final 
regulations do not incorporate this comment because under current 
regulations, a substantial number of new markets tax credits 
investments are already being made in owner-occupied facilities. The 
purpose of these final regulations is to encourage more new markets tax 
credits investments not related to real estate.
    Commentators also requested that if a non-real estate qualified 
active low-income community business is allowed to use investments for 
construction or improvements to real estate facilities primarily used 
in its business, then the definition of working capital under Sec.  
1.45D-1(d)(4)(i)(E)(2) should include the proceeds of an equity 
investment or a loan that the non-real estate qualified active low-
income community business will expend for the construction of real 
property within 18 months (as opposed to 12 months) after the date of 
the investment or loan. The final regulations do not incorporate this 
comment because the final rules for non-real estate qualified active 
low-income community businesses do not pertain to investments for 
construction or improvements to real estate facilities.
    In response to comments, the final regulations clarify that an 
investment in a non-real estate qualified active low-income community 
business may be made through one or more CDEs. Thus, for example, a CDE 
that designates an equity investment as a non-real estate qualified 
equity investment may invest the proceeds in another CDE if that 
investment is directly traceable to a non-real estate qualified active 
low-income community business.

Payments of Capital, Equity, or Principal With Respect to a Non-Real 
Estate Qualified Active Low-Income Community Business

    The proposed regulations require that any portion that the CDE 
chooses to reinvest in a certified CDFI must be reinvested by the CDE 
no later than 30 days from the date of receipt to be treated as 
continuously invested in a qualified low-income community investment. 
Commentators requested that instead of 30 days, CDEs invested in a non-
real estate qualified active low-income community business should have 
12 months to decide whether to reinvest capital, equity, or principal 
in another non-real estate qualified active low-income community 
business or a certified CDFI under Sec.  1.45D-1(d)(9)(ii) (similar to 
the 12-month reinvestment requirement in Sec.  1.45D-1(d)(2)(i)). The 
final regulations do not incorporate this comment because a CDE that 
has not found a new non-real estate qualified active low-income 
community business to invest in at the expiration of the 30 day period 
can invest the capital, equity, or principal in a certified CDFI until 
it finds a suitable non-real estate qualified active low-income 
community business. It can then withdraw its investment in the 
certified CDFI and invest that capital, equity, or principal in the 
suitable non-real estate qualified active low-income community 
business.
    Commentators also requested that the final regulations allow a CDE 
that makes an equity investment in a non-real estate qualified active 
low-income community business to reinvest up to 100 percent of its 
equity investment in a certified CDFI under Sec.  1.45D-1(d)(9)(ii) 
after the first year of the 7-year credit period. The commentators 
explained that this would encourage venture capital investments

[[Page 59546]]

in a non-real estate qualified active low-income community business 
because liquidity events (cashing out some or all of an investment) 
occurring early in the 7-year credit period, which often happen with 
venture capital investments, would not automatically cause recapture. 
The final regulations do not incorporate this comment because the 
proposal could create a situation in which the proceeds of the new 
markets tax credit investment may only be invested in a qualified 
active low-income community business for a brief period without any new 
markets tax credit restrictions on how a certified CDFI may use the 
proceeds. Such a result would be inconsistent with encouraging 
investments in qualified active low-income community businesses during 
the 7-year credit period.
    Commentators also requested that the final regulations allow a CDE 
to invest returns of capital, equity, or principal into entities other 
than certified CDFIs under Sec.  1.45D-1(d)(9)(ii). Such entities would 
include non-profit and for-profit entities focused on economic and 
community development, funds that provide equity and loans to small and 
medium businesses, and funds that provide equity or loans to minority 
and women owned businesses. The final regulations do not incorporate 
this comment because it would make administering the final regulations 
unworkable given the breadth of potential reinvestment vehicles. The 
final regulations allow investments in certified CDFIs because there 
are rules that ensure that a certified CDFI serves low-income 
communities. Such rules do not currently exist for other potential 
reinvestment entities. However, the final regulations provide that in 
the future the Secretary may designate other qualifying entities in the 
Internal Revenue Bulletin. See Sec.  601.601(d)(2)(ii)(b).
    Section 1.45D-1(d)(9) of the proposed regulations is renumbered as 
Sec.  1.45D-1(d)(10) in the final regulations due to the amendments 
made by TD 9560 involving targeted populations.

Lines of Credit

    A commentator requested that the final regulations consider the 
entire amount of a line of credit as outstanding loan principal for 
purposes of the substantially-all requirement under Sec.  1.45D-
1(c)(5)(i). Lines of credit often serve the capital needs of non-real 
estate businesses better than fully disbursed loans with fixed terms, 
which may be more appropriate for real estate investments. The IRS and 
the Treasury Department are studying these issues and may address them 
in future guidance.

Other Comments

    Other comments were received on issues unrelated to the proposed 
regulations. The final regulations do not incorporate comments that are 
outside the scope of the proposed regulations, although they may be 
relevant to future guidance under the new markets tax credit.

Effective Date/Applicability

    The IRS and the Treasury Department received a few comments 
regarding whether the final regulations should allow a qualified equity 
investment made before the effective date of the final regulations to 
be eligible for designation as a non-real estate qualified equity 
investment. The majority of commentators recommended not adopting a 
look-back rule because it would be confusing and complicate compliance. 
After further examination, the IRS and the Treasury Department agree 
with these commentators. Further, allowing CDEs to designate 
investments as non-real estate after the investments are made does not 
serve the purpose of incentivizing new investments in non-real estate 
projects. Section 1.45D-1(c)(1)(iii) requires that an investment in a 
non-real estate qualified equity investment must be designated as such 
for a CDE to qualify for benefits allowed under the final regulations. 
Accordingly, the final regulations apply to equity investments made on 
or after the date the final regulations are published in the Federal 
Register.

Special Analyses

    This Treasury decision is not a significant regulatory action as 
defined in Executive Order 12866, as supplemented by Executive Order 
13563. Therefore, a regulatory assessment is not required. Section 
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does 
not apply to these regulations, and because the regulations do not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Internal Revenue Code, the notice of proposed 
rulemaking that preceded these final regulations was submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business and no comments were received.

Drafting Information

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

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    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-0 is amended by:
0
1. Adding entries for paragraphs (c)(8), (d)(10), (d)(10)(i), 
(d)(10)(ii), (d)(10)(ii)(A), (d)(10)(ii)(B), (d)(10)(ii)(C), 
(d)(10)(ii)(D), and (h)(4).

0
2. Revising the entry for paragraph (d)(1)(i).
    The additions and revisions read as follows:


Sec.  1.45D-0  Table of contents.

* * * * *
    (c) * * *
    (8) Non-real estate qualified equity investment.
    (d) * * *
    (1) * * *
    (i) Investment in a qualified active low-income community business 
or a non-real estate qualified active low-income community business.
* * * * *
    (10) Non-real estate qualified active low-income community 
business.
    (i) Definition.
    (ii) Payments of, or for, capital, equity or principal with respect 
to a non-real estate qualified active low-income community business.
    (A) In general.
    (B) Seventh year of the 7-year credit period.
    (C) Amounts received from a qualifying entity.
    (D) Definition of qualifying entity.
* * * * *
    (h) * * *
    (4) Investments in non-real estate businesses.
* * * * *

0
Par. 3. Section 1.45D-1 is amended by:
0
1. Revising paragraphs (c)(1)(iii), (c)(3)(ii) introductory text, and 
(d)(1)(i).
0
2. Amending paragraph (h)(1) by removing the language ``paragraph

[[Page 59547]]

(h)(2)'' and adding ``paragraphs (h)(2), (h)(3), and (h)(4)'' in its 
place.
0
3. Adding new paragraphs (c)(8), (d)(10), and (h)(4).
    The additions and revisions read as follows:


Sec.  1.45D-1  New markets tax credit.

* * * * *
    (c) * * *
    (1) * * *
    (iii) The investment is designated for purposes of section 45D and 
this section as a qualified equity investment or a non-real estate 
qualified equity investment (as defined in paragraph (c)(8) of this 
section) by the CDE on its books and records using any reasonable 
method.
* * * * *
    (3) * * *
    (ii) Exceptions. Notwithstanding paragraph (c)(3)(i) of this 
section, an equity investment in an entity is eligible to be designated 
as a qualified equity investment or a non-real estate qualified equity 
investment under paragraph (c)(1)(iii) of this section if--
* * * * *
    (8) Non-real estate qualified equity investment. If a qualified 
equity investment is designated as a non-real estate qualified equity 
investment under paragraph (c)(1)(iii) of this section, then the 
qualified equity investment may only satisfy the substantially-all 
requirement under paragraph (c)(5) of this section if the CDE makes 
qualified low-income community investments that are directly traceable 
(including investments made through one or more CDEs) to non-real 
estate qualified active low-income community businesses (as defined in 
paragraph (d)(10) of this section). The proceeds of a non-real estate 
qualified equity investment cannot be used for transactions involving a 
qualified active low-income community business that is not a non-real 
estate qualified active low-income community business.
    (d) * * *
    (1) * * *
    (i) Investment in a qualified active low-income community business 
or a non-real estate qualified active low-income community business. 
Any capital or equity investment in, or loan to, any qualified active 
low-income community business (as defined in paragraph (d)(4) of this 
section) or any non-real estate qualified active low-income community 
business (as defined in paragraph (d)(10) of this section).
* * * * *
    (10) Non-real estate qualified active low-income community 
business--(i) Definition. The term non-real estate qualified active 
low-income community business means any qualified active low-income 
community business (as defined in paragraph (d)(4) of this section) 
whose predominant business activity does not include the development 
(including construction of new facilities and rehabilitation/
enhancement of existing facilities), management, or leasing of real 
estate. For purposes of the preceding sentence, predominant business 
activity means a business activity that generates more than 50 percent 
of the business' gross income. The purpose of the capital or equity 
investment in, or loan to, the non-real estate qualified active low-
income community business must not be connected to the development 
(including construction of new facilities and rehabilitation/
enhancement of existing facilities), management, or leasing of real 
estate.
    (ii) Payments of, or for, capital, equity or principal with respect 
to a non-real estate qualified active low-income community business--
(A) In general. For purposes of paragraph (d)(2)(i) of this section, a 
portion of the amounts received by a CDE in payment of, or for, 
capital, equity, or principal with respect to a non-real estate 
qualified active low-income community business after year one of the 7-
year credit period (as defined by paragraph (c)(5)(i) of this section) 
may be reinvested by the CDE in a qualifying entity (as defined in 
paragraph (d)(10)(ii)(D)). Any portion that the CDE chooses to reinvest 
in a qualifying entity must be reinvested by the CDE no later than 30 
days from the date of receipt to be treated as continuously invested in 
a qualified low-income community investment for purposes of paragraph 
(d)(2)(i) of this section. If the amount reinvested in a qualifying 
entity exceeds the maximum aggregate portion of the non-real estate 
qualified equity investment, then the excess will not be treated as 
invested in a qualified low-income community investment. The maximum 
aggregate portion of the non-real estate qualified equity investment 
that may be reinvested into a qualifying entity, which will be treated 
as continuously invested in a qualified low-income community 
investment, may not exceed the following percentages of the non-real 
estate qualified equity investment in the following years:
    (1) 15 percent in Year 2 of the 7-year credit period.
    (2) 30 percent in Year 3 of the 7-year credit period.
    (3) 50 percent in Year 4 of the 7-year credit period.
    (4) 85 percent in Year 5 and Year 6 of the 7-year credit period.
    (B) Seventh year of the 7-year credit period. Amounts received by a 
CDE in payment of, or for, capital, equity, or principal with respect 
to a non-real estate qualified active low-income community business (as 
defined in paragraph (d)(10)(i) of this section) during the seventh 
year of the 7-year credit period do not have to be reinvested by the 
CDE in a qualified low-income community investment to be treated as 
continuously invested in a qualified low-income community investment.
    (C) Amounts received from qualifying entity. Except for the seventh 
year of the 7-year credit period under paragraph (d)(10)(ii)(B) of this 
section, amounts received from a qualifying entity must be reinvested 
by the CDE no later than 30 days from the date of receipt to be treated 
as continuously invested in a qualified low-income community 
investment.
    (D) Definition of qualifying entity. For purposes of paragraphs 
(d)(10)(ii) and (d)(10)(iii) of this section, a qualifying entity is--
    (1) A certified community development financial institution 
(certified CDFI) that is a CDE under section 45D(c)(2)(B) (as defined 
by 12 CFR 1805.201), which is unrelated to the CDE making the 
investment in the certified CDFI within the meaning of section 267(b) 
or section 707(b)(1); or
    (2) An entity designated by the Secretary by publication in the 
Internal Revenue Bulletin (see Sec.  601.601(d)(2)(ii)(b) of this 
chapter).
* * * * *
    (h) * * *
    (4) Investments in non-real estate businesses. Paragraphs (c)(8) 
and (d)(10) of this section apply to equity investments in CDEs made on 
or after September 28, 2012.

 Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
    Approved: September 21, 2012.
 Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2012-23985 Filed 9-26-12; 11:15 am]
BILLING CODE 4830-01-P