New Markets Tax Credit.

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1 and 602 [TD 8971] RIN 1545-
BA49

TITLE: New Markets Tax Credit

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations that provide
guidance for taxpayers claiming the new markets tax credit under
section 45D. A taxpayer making a qualified equity investment in a
qualified community development entity that has received a new
markets tax credit allocation may claim a 5-percent tax credit with
respect to the qualified equity investment on each of the first 3
credit allowance dates and a 6-percent tax credit with respect to
the qualified equity investment on each of the remaining 4 credit
allowance dates. 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 REG-119436-01 published
elsewhere in this issue of the Federal Register .

DATES: Effective Date: These regulations are effective December 26,
2001. Date of Applicability: For date of applicability of
§1.45D-1T, see §1.45D-1T(h).

FOR FURTHER INFORMATION CONTACT: Paul Handleman, (202) 622-3040.

SUPPLEMENTARY INFORMATION:.

aperwork Reduction Act

These regulations are being issued without prior notice and public
procedure pursuant to the Administrative Procedure Act (5 U.S.C.
553). For this reason, the collections of information contained in
these regulations have been reviewed and, pending receipt and
evaluation of public comments, approved by the Office of Management
and Budget under control number 1545-1765. Responses to these
collections of information are mandatory.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid OMB control number.

For further information concerning these collections of information,
and where to submit comments on the collections of information and
the accuracy of the estimated burden, and suggestions for reducing
this burden, please refer to the preamble to the cross-referencing
notice of proposed rulemaking published in the Proposed Rules
section of this issue of the Federal Register .

Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.

Background

This document contains temporary regulations relating to the new
markets tax credit under section 45D of the Internal Revenue Code
(Code). This provision was added to the Code by section 121(a) of
the Community Renewal Tax Relief Act of 2000 (Public Law 106-554).
The Secretary has delegated certain administrative, application,
allocation, monitoring, and other programmatic functions relating to
the new markets tax credit program to the Under Secretary (Domestic
Finance), who in turn has delegated those functions to the Community
Development Financial Institutions Fund (CDFI Fund).

On May 1, 2001, the IRS published an advance notice of proposed
rulemaking in the Federal Register (66 FR 21844) inviting comments
relating to tax issues arising under section 45D. Numerous comments
have been received. The IRS and Treasury Department have reviewed
and considered all the comments in the process of preparing this
Treasury decision. This preamble to the temporary regulations
describes many, but not all, of the comments received by the IRS.

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. Most commentators suggest that the
substantially-all test should require that at least 85 percent of
the taxpayer's cash be committed to, or invested in, qualified low-
income community investments. Some commentators propose that in
order to provide CDEs with financial flexibility in managing their
investments, the percentage should be reduced for the later years of
the 7-year credit period. The temporary regulations adopt the
suggestion to define substantially all as 85 percent or more and
reduce the substantially-all percentage to 75 percent for the
seventh year of the 7-year credit period.

Some commentators suggest that a CDE's costs of obtaining equity
investments in the CDE (such as underwriters' fees and broker fees)
and the CDE's overhead expenses (such as staff salaries) should
count toward satisfying the substantially-all requirement. Some
commentators suggest that reserves maintained by the CDE of up to 10
percent of the taxpayer's cash investment in the CDE should count
toward satisfying the substantially-all requirement. The temporary
regulations do not include issuance costs or CDE overhead expenses
as counting toward the substantially-all requirement. However, the
temporary regulations provide that reserves (but not in excess of 5
percent of the taxpayer's cash investment) for loan losses and for
additional investments in existing qualified low-income community
investments are treated as invested in a qualified low-income
community investment.

Several commentators suggest that, for purposes of the "85 percent
of the aggregate gross assets" safe harbor, aggregate gross assets
should be determined according to cost basis and not, for example,
fair market value. The temporary regulations adopt this suggestion.
Cost basis is defined under the temporary regulations as cost basis
under section 1012.

Commentators propose that a CDE should have from 12 months to 5
years to invest the cash from a qualified equity investment in a
qualified low-income community investment, depending upon the type
of investment. The temporary regulations adopt a 12-month period for
investing the taxpayer's cash investment.

Commentators propose that repayments to a CDE of equity or principal
from qualified low-income community investments should have to be
reinvested by the CDE within 12 months, but that no reinvestment
should be required in the sixth and seventh years of the 7-year
credit period. One commentator proposes that reinvestment should be
encouraged, but not required. Another commentator would limit the
time period to 45 days for identifying the investment and 180 days
for making the investment. The temporary regulations adopt the
suggestion that repayment amounts reinvested within 12 months are
treated as continuously invested in qualified low-income community
investments. In addition, repayments received in the seventh year of
the 7-year credit period are not required to be reinvested.

Qualified Active Low-Income Community Businesses

As indicated above, qualified low-income community investments
include any capital or equity investment in, or loan to, any
qualified active low-income community business. A business is a
qualified active low-income community business only if, among other
things: (1) at least 50 percent of the total gross income of the
business 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 business is within any low-
income community; and (3) a substantial portion of the services
performed for the business by its employees is performed in any low-
income community.

Commentators propose that, to satisfy the "50 percent of the total
gross income ... derived from the active conduct" requirement (50-
percent requirement) in the case of a manufacturing business, 50
percent of production, but not sales, should have to occur within a
low-income community. For a services business, commentators.
recommend a requirement that at least 50 percent of the services be
provided by employees of offices in low-income communities even if
the services are provided elsewhere. One commentator suggests that
the 50-percent requirement should be deemed met if the business is
located in the low-income community and most of the employees are
residents of the low-income community. Another commentator suggests
that the requirement should be satisfied if 50 percent of the total
gross income is derived from: (1) the operation of, or production
at, a facility located in a low-income community; (2) most of the
employees are based at such a facility; and (3) the management is
located within the low-income community.

For purposes of the tangible property and services performed
requirements, recommendations for the percentage that should
constitute a substantial portion range from 20 percent to 50
percent. Alternatively, some commentators propose that the tangible
property and services performed requirements should be satisfied if
the business satisfies one of the following: (1) the business is
located in a qualified area; (2) the business operates a major
facility in a qualified area; (3) the business' primary business
activity takes place in a qualified area; or (4) the business'
primary mission is working with people in qualified areas.

For purposes of the tangible property and services performed
requirements, the temporary regulations define a substantial portion
as 40 percent. In addition, the temporary regulations provide that
the 50-percent requirement is deemed to be satisfied if the entity
meets the requirements of either the tangible property test or the.
services performed test, if 50 percent is substituted for 40
percent. Further, the entity may satisfy the 50-percent requirement
based on all the facts and circumstances. Commentators propose that
for purposes of determining when a trade or business constitutes a
qualified active low-income community business, an entity should
qualify 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. This proposal has been adopted in the temporary regulations,
except in the case where the CDE controls the entity.

If the CDE controls the entity at any time during the 7-year credit
period, the reasonable expectation test does not apply and the
entity must be a qualified active low-income community business
during the entire period the CDE controls the entity. Commentators
suggest that control for this purpose should be defined as at least
50 percent of voting power. Some commentators suggest that control
should be determined based on whether the CDE is related to the
entity within the meaning of sections 267(b) or 707(b)(1). The
temporary regulations define 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.
However, a CDE does not control an entity if an unrelated person
possesses greater control over the entity than the CDE.

Financial Counseling and Other Services

Commentators suggest that the definition of financial counseling and
other services should include services for identifying CDE
investment opportunities; preparing business owners to use financial
products; underwriting loans and investments; helping business
owners create viable business plans; and, after loans and
investments are made, enhancing business planning, marketing,
management, and financial skills of business owners and serving on
their boards of directors. The temporary regulations define
financial counseling and other services as advice provided by the
CDE relating to the organization or operation of a trade or business
that is provided to a qualified active low-income community business
or to residents of a low-income community.

Investments in Other CDEs

Commentators propose that, for purposes of the substantially-all
requirement, tracing should not be required when a CDE invests in
another CDE, but other mechanisms should be required (for example,
decertifying the recipient CDE if it does not use funds properly).
Alternatively, commentators propose tracing at the recipient CDE
level, but minimizing the reporting and recapture burdens for the
recipient CDEs. Some commentators suggest that the recipient CDE
should have the same restrictions placed on it as the investing CDE.
The temporary regulations provide that an equity investment in, or
loan to, another CDE is a qualified low-income community investment
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.

Recapture

A recapture event requiring an investor to recapture credits
previously taken may occur for an equity investment in a CDE if the
CDE: (1) ceases to be a CDE; (2) ceases to use substantially all of
the proceeds of the equity investment for qualified low-income
community investments; or (3) redeems the investor's equity
investment. Commentators suggest that a CDE should be permitted to
take remedial actions to avoid recapture. The temporary regulations
adopt this suggestion by providing a CDE the opportunity to request
a waiver of a requirement or an extension of time to meet a deadline
contained in the temporary regulations if such waiver or extension
does not materially frustrate the purposes of section 45D and the
regulations thereunder. A CDE that believes it has good cause for a
waiver or an extension may request relief from the Commissioner in a
ruling request. In considering such a ruling request, the
Commissioner may consult with the CDFI Fund in a manner consistent
with section 6103. The granting of a waiver or an extension may
require adjustments of the CDE's requirements under section 45D and
the regulations thereunder as may be appropriate.

Other Federal Tax Benefits

The Treasury Department is authorized to prescribe regulations that
limit the new markets tax credit for investments that are directly
or indirectly subsidized by other Federal tax benefits (including
the low-income housing tax credit under section 42 and the exclusion
from gross income under section 103). Commentators suggest that a
CDE should not be permitted to use the proceeds of a qualified
equity investment to purchase tax-exempt bonds. However, the same
commentators state that there should be no restriction on the
receipt of tax-exempt bond proceeds by a qualified active low-income
community business. The temporary regulations do not prohibit a CDE
from purchasing tax-exempt bonds because tax-exempt financing
provides a subsidy to borrowers and not bondholders. Moreover, a
loan by a CDE directly to a qualified active low-income community
business cannot be a tax-exempt bond because the loan is not an
obligation of a state or local government. Because the rental to
others of residential rental property cannot be a qualified active
low-income community business, a taxpayer cannot receive the low-
income housing tax credit and new markets tax credit on the same
investment. Although the temporary regulations do not provide
specific rules on double tax benefit issues, the IRS and the
Treasury Department request additional comments on what Federal tax
benefits should limit the new markets tax credit.

Reporting Requirements

The Treasury Department is authorized to prescribe regulations that
impose appropriate reporting requirements for the new markets tax
credit. Commentators suggest that the information reporting to the
Treasury Department should be undertaken on an annual basis and that
CDEs should be required to provide the following information:
financial statements, a list of investors and closing and commitment
dates, a list of eligible investments, terms of investments and
location of. investments, information on loan loss or investments
reserves, and information on financial counseling and other
services.

The reporting requirements in the temporary regulations require a
CDE to provide notice: (1) to any taxpayer who acquires a qualified
equity investment in the CDE at its original issue that the equity
investment is a qualified equity investment entitling the taxpayer
to claim the new markets tax credit; and (2) in the case of a
recapture event, to each holder of an equity investment, including
all prior holders of that investment, that a recapture event has
occurred. CDEs must comply with such reporting requirements to the
Secretary as the Secretary may prescribe. Taxpayers may claim the
new markets tax credit by completing Form 8874, "New Markets
Credit," and by filing the form with the taxpayer's Federal income
tax return.

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 is hereby
certified that the collection of information in these regulations
will not have a significant economic impact on a substantial number
of small entities. This certification is based upon the fact that
any burden on taxpayers is minimal. Accordingly, a Regulatory
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Pursuant to section 7805(f) of the Code,
these 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

26 CFR Part 1 Income taxes, Reporting and recordkeeping
requirements.

26 CFR Part 602 Reporting and recordkeeping requirements.

Amendments to the Regulations Accordingly, 26 CFR parts 1 and 602
are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows: Authority: 26 U.S.C.
7805 * * *

Section 1.45D-1T also issued under 26 U.S.C. 45D(i); * * *

Par. 2. Section 1.45D-1T is added to read as follows: §1.45D-1T
New markets tax credit.

(a) Table of contents. This paragraph lists the headings that appear
in §1.45D-1T.

(a) Table of contents.

(b) Allowance of credit

(1) In general.

(2) Credit allowance date.

(3) Applicable percentage.

(4) Amount paid at original issue.

(c) Qualified equity investment.

(1) In general.

(2) Equity investment.

(3) Equity investments made prior to allocation.

(i) In general.

(ii) Exception.

(iii) Initial investment date.

(4) Limitations.

(i) In general.

(ii) Allocation limitation.

(5) Substantially all.

(i) In general.

(ii) Direct-tracing calculation.

(iii) Safe harbor calculation.

(iv) Time limit for making investments.

(v) Reduced substantially-all percentage.

(6) Aggregation of equity investments.

(7) Subsequent purchasers.

(d) Qualified low-income community investments.

(1) In general.

(i) Investment in a qualified active low-income community business.

(ii) Purchase of certain loans from CDEs.

(iii) Financial counseling and other services.

(iv) Investments in other CDEs.

(2) Payments of, or for, capital, equity or principal.

(i) In general.

(ii) Subsequent reinvestments.

(iii) Special rule for loans.

(iv) Example.

(3) Special rule for reserves.

(4) Qualified active low-income community business.

(i) In general.

(A) Gross-income requirement.

(B) Use of tangible property.

(C) Services performed.

(D) Collectibles.

(E) Nonqualified financial property.

(ii) Proprietorships.

(iii) Portions of business.

(5) Qualified business.

(i) In general.

(ii) Rental of real property..

(iii) Exclusions.

(A) Trades or businesses involving intangibles.

(B) Certain other trades or businesses.

(C) Farming.

(6) Qualifications.

(i) In general.

(ii) Control.

(A) In general.

(B) Definition of control.

(7) Financial counseling and other services.

(e) Recapture.

(1) In general.

(2) Recapture event.

(3) Bankruptcy.

(4) Waiver of requirement or extension of time.

(i) In general.

(ii) Manner for requesting a waiver or extension.

(iii) Terms and conditions.

(5) Example.

(f) Basis reduction.

(1) In general.

(2) Adjustment in basis of interest in partnership or S corporation.

(g) Other rules.

(1) Anti-abuse.

(2) Reporting requirements.

(i) Notification by CDE to taxpayer.

(A) Allowance of new markets tax credit.

(B) Recapture event.

(ii) CDE reporting requirements to Secretary.

(iii) Manner of claiming new markets tax credit.

(iv) Reporting recapture tax.

(h) Effective date.

(b) Allowance of credit--(1) In general. For purposes of the general
business credit under section 38, a taxpayer holding a qualified
equity investment on a credit allowance date which occurs during the
taxable year may claim the new markets tax credit determined under
section 45D and this section for such taxable year in an amount
equal to the applicable percentage of the amount paid to a qualified
community. development entity (CDE) for such investment at its
original issue. Qualified equity investment is defined in paragraph
(c) of this section. Credit allowance date is defined in paragraph
(b)(2) of this section. Applicable percentage is defined in
paragraph

(b)(3) of this section. A CDE is a qualified community development
entity as defined in section 45D(c). The amount paid at original
issue is determined under paragraph

(b)(4) of this section.

(2) Credit allowance date. The term credit allowance date means,
with respect to any qualified equity investment--

(i) The date on which the investment is initially made; and

(ii) Each of the 6 anniversary dates of such date thereafter.

(3) Applicable percentage. The applicable percentage is 5 percent
for the first 3 credit allowance dates and 6 percent for the other 4
credit allowance dates.

(4) Amount paid at original issue. The amount paid to the CDE for a
qualified equity investment at its original issue consists of all
amounts paid by the taxpayer to, or on behalf of, the CDE (including
any underwriter's fees) to purchase the investment at its original
issue.

(c) Qualified equity investment--(1) In general. The term qualified
equity investment means any equity investment (as defined in
paragraph (c)(2) of this section) in a CDE if--

(i) The investment is acquired by the taxpayer at its original issue
(directly or through an underwriter) solely in exchange for
cash;.-18-

(ii) Substantially all (as defined in paragraph (c)(5) of this
section) of such cash is used by the CDE to make qualified low-
income community investments (as defined in paragraph (d)(1) of this
section); and

(iii) The investment is designated for purposes of section 45D and
this section by the CDE on its books and records using any
reasonable method.

(2) Equity investment. The term equity investment means any stock
(other than nonqualified preferred stock as defined in section
351(g)(2)) in an entity that is a corporation for Federal tax
purposes and any capital interest in an entity that is a partnership
for Federal tax purposes. See §§301.7701-1 through
301.7701-3 of this chapter for rules governing when a business
entity, such as a business trust or limited liability company, is
classified as a corporation or a partnership for Federal tax
purposes.

(3) Equity investments made prior to allocation--(i) In general.
Except as provided in paragraph (c)(3)(ii) of this section, an
equity investment in an entity is not eligible to be designated as a
qualified equity investment if it is made before the entity enters
into an allocation agreement with the Secretary. An allocation
agreement is an agreement between the Secretary and a CDE relating
to a new markets tax credit allocation under section 45D(f)(2).

(ii) Exception. Notwithstanding paragraph (c)(3)(i) of this section,
an equity investment in an entity is eligible to be designated as a
qualified equity investment under paragraph (c)(1)(iii) of this
section if--

(A) The equity investment is made on or after April 20, 2001;

(B) The entity in which the equity investment is made is certified
by the Secretary as a CDE under section 45D(c) before January 1,
2003;

(C) The entity in which the equity investment is made receives
notification of the credit allocation (with the actual receipt of
such credit allocation contingent upon subsequently entering into an
allocation agreement) from the Secretary before January 1, 2003; and

(D) The equity investment otherwise satisfies the requirements of
section 45D and this section.

(iii) Initial investment date. If an equity investment is designated
as a qualified equity investment in accordance with paragraph (c)(3)
(ii) of this section, the investment is treated as initially made on
the effective date of the allocation agreement between the CDE and
the Secretary.

(4) Limitations--(i) In general. The term qualified equity
investment does not include--

(A) Any equity investment issued by a CDE more than 5 years after
the date the CDE enters into an allocation agreement (as defined in
paragraph (c)(3)(i) of this section) with the Secretary; and

(B) Any equity investment by a CDE in another CDE, if the CDE making
the investment has received an allocation under section 45D(f)(2).

(ii) Allocation limitation. The maximum amount of equity investments
issued by a CDE that may be designated under paragraph (c)(1)(iii)
of this section by the CDE may not exceed the portion of the
limitation amount allocated to the CDE by the Secretary under
section 45D(f)(2).

(5) Substantially all--(i) In general. Except as provided in
paragraph (c)(5)(v) of this section, the term substantially all
means at least 85 percent. The substantially-all requirement must be
satisfied for each annual period in the 7-year credit period 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. The substantially-all requirement is treated
as satisfied for an annual period if 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, is
performed every six months and the average of the two calculations
for the annual period is at least 85 percent. For purposes of this
paragraph (c)(5)(i), the 7-year credit period means the period of 7
years beginning on the date the qualified equity investment is
initially made. See paragraph (c)(6) of this section for
circumstances in which a CDE may treat more than one equity
investment as a single qualified equity investment.

(ii) Direct-tracing calculation. The substantially-all requirement
is satisfied if at least 85 percent of the taxpayer's investment is
directly traceable to qualified low-income community investments as
defined in paragraph (d)(1) of this section. The direct-tracing
calculation is a fraction the numerator of which is the CDE's
aggregate cost basis determined under section 1012 in all of the
qualified low-income community investments that are directly
traceable to the taxpayer's cash investment, and the denominator of
which is the amount of the taxpayer's cash investment under
paragraph. (b)(4) of this section. For purposes of this paragraph
(c)(5)(ii), cost basis includes the cost basis of any qualified low-
income community investment that becomes worthless. See paragraph
(d)(2) of this section for the treatment of amounts received by a
CDE in payment of, or for, capital, equity or principal with respect
to a qualified low-income community investment.

(iii) Safe harbor calculation. The substantially-all requirement is
satisfied if at least 85 percent of the aggregate gross assets of
the CDE are invested in qualified low-income community investments
as defined in paragraph (d)(1) of this section. The safe harbor
calculation is a fraction the numerator of which is the CDE's
aggregate cost basis determined under section 1012 in all of its
qualified low-income community investments, and the denominator of
which is the CDE's aggregate cost basis determined under section
1012 in all of its assets. For purposes of this paragraph (c)(5)
(iii), cost basis includes the cost basis of any qualified low-
income community investment that becomes worthless. See paragraph
(d)(2) of this section for the treatment of amounts received by a
CDE in payment of, or for, capital, equity or principal with respect
to a qualified low-income community investment.

(iv) Time limit for making investments. The taxpayer's cash
investment received by a CDE is treated as invested in a qualified
low-income community investment as defined in paragraph (d)(1) of
this section only to the extent that the cash is so invested no
later than 12 months after the date the cash is paid by the taxpayer
(directly or through an underwriter) to the CDE.

(v) Reduced substantially-all percentage. For purposes of the
substantially-all requirement (including the direct-tracing
calculation under paragraph (c)(5)(ii) of this section and the safe
harbor calculation under paragraph (c)(5)(iii) of this section), 85
percent is reduced to 75 percent for the seventh year of the 7-year
credit period (as defined in paragraph (c)(5)(i) of this section).

(6) Aggregation of equity investments. A CDE may treat any qualified
equity investments issued on the same day as one qualified equity
investment. If a CDE aggregates equity investments under this
paragraph (c)(6), the rules in this section shall be construed in a
manner consistent with that treatment.

(7) Subsequent purchasers. A qualified equity investment includes
any equity investment that would (but for paragraph (c)(1)(i) of
this section) be a qualified equity investment in the hands of the
taxpayer if the investment was a qualified equity investment in the
hands of a prior holder.

(d) Qualified low-income community investments--(1) In general. The
term qualified low-income community investment means any of the
following--

(i) Investment in a 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).

(ii) Purchase of certain loans from CDEs. The purchase 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 from another CDE is a qualified low-income community
investment if it qualifies as such either--

(A) At the time the selling CDE made the loan; or

(B) At the time the loan is purchased from the selling CDE.

(iii) Financial counseling and other services. Financial counseling
and other services (as defined in paragraph (d)(7) of this section)
provided to any qualified active low-income community business, or
to any residents of a low-income community (as defined in section
45D(e)).

(iv) Investments in other CDEs. Any equity investment in, or loan
to, any CDE, but only to the extent that the CDE in which the equity
investment or loan is made uses the proceeds of the investment or
loan in a manner--

(A) That is described in paragraphs (d)(1)(i) or (iii) of this
section; and

(B) That would constitute a qualified low-income community
investment if it were made directly by the CDE making such equity
investment or loan.

(2) Payments of, or for, capital, equity or principal--(i) In
general. Except as otherwise provided in this paragraph (d)(2),
amounts received by a CDE in payment of, or for, capital, equity or
principal with respect to a qualified low-income community
investment must be reinvested by the CDE in a qualified low-income
community investment no later than 12 months from the date of
receipt to be treated as continuously invested in a qualified low-
income community investment. If the amounts received by the CDE are
equal to or greater than the cost basis of the original qualified
low-income community investment (or applicable portion thereof), and
the CDE reinvests, in accordance with this paragraph (d)(2)(i), an
amount at least equal to such original cost basis, then an amount
equal to such original cost basis will be treated as continuously
invested in a qualified low-income community investment. In
addition, if the amounts received by the CDE are equal to or greater
than the cost basis of the original qualified low-income community
investment (or applicable portion thereof), and the CDE reinvests,
in accordance with this paragraph (d)(2)(i), an amount less than
such original cost basis, then only the amount so reinvested will be
treated as continuously invested in a qualified low-income community
investment. If the amounts received by the CDE are less than the
cost basis of the original qualified low-income community investment
(or applicable portion thereof), and the CDE reinvests an amount in
accordance with this paragraph (d)(2)(i), then the amount treated as
continuously invested in a qualified low-income community investment
will equal the excess (if any) of such original cost basis over the
amounts received by the CDE that are not so reinvested. Amounts
received by a CDE in payment of, or for, capital, equity or
principal with respect to a qualified low-income community
investment during the seventh year of the 7-year credit period (as
defined in paragraph (c)(5)(i) of this section) do not have to be
reinvested by the CDE in a qualified low-income community investment
in order to be treated as continuously invested in a qualified low-
income community investment.

(ii) Subsequent reinvestments. In applying paragraph (d)(2)(i) of
this section to subsequent reinvestments, the original cost basis is
reduced by the amount (if any) by which the original cost basis
exceeds the amount determined to be continuously invested in a
qualified low-income community investment.

(iii) Special rule for loans. Periodic amounts received during a
calendar year as repayment of principal on a loan that is a
qualified low-income community investment are treated as
continuously invested in a qualified low-income community investment
if the amounts are reinvested in another qualified low-income
community investment by the end of the following calendar year.

(iv) Example. The application of paragraphs (d)(2)(i) and (ii) of
this section is illustrated by the following example:

Example. On April 1, 2003, A, B, and C each pay $100,000 to acquire
a capital interest in X, a partnership. X is a CDE that has received
a new markets tax credit allocation from the Secretary. X treats the
3 partnership interests as one qualified equity investment under
paragraph (c)(6) of this section. In August 2003, X uses the
$300,000 to make a qualified low-income community investment under
paragraph (d)(1) of this section. In August 2005, the qualified low-
income community investment is redeemed for $250,000. In February
2006, X reinvests $230,000 of the $250,000 in a second qualified
low-income community investment and uses the remaining $20,000 for
operating expenses. Under paragraph (d)(2)(i) of this section,
$280,000 of the proceeds of the qualified equity investment is
treated as continuously invested in a qualified low-income community
investment. In December 2008, X sells the second qualified low-
income community investment and receives $400,000. In March 2009, X
reinvests $320,000 of the $400,000 in a third qualified low-income
community investment. Under paragraphs (d)(2)(i) and (ii) of this
section, $280,000 of the proceeds of the qualified equity investment
is treated as continuously invested in a qualified low-income
community investment ($40,000 is treated as invested in another
qualified low-income community investment in March 2009).

(3) Special rule for reserves. Reserves (not in excess of 5 percent
of the taxpayer's cash investment under paragraph (b)(4) of this
section) maintained by the CDE for loan losses or for additional
investments in existing qualified low-income. community investments
are treated as invested in a qualified low-income community
investment under paragraph (d)(1) of this section.

(4) Qualified active low-income community business--(i) In general.
The term qualified active low-income community business means, with
respect to any taxable year, a corporation (including a nonprofit
corporation) or a partnership, if the requirements in paragraphs (d)
(4)(i)(A), (B), (C), (D), and (E) are met.

(A) Gross-income requirement. At least 50 percent of the total gross
income of such entity is derived from the active conduct of a
qualified business (as defined in paragraph (d)(5) of this section)
within any low-income community (as defined in section 45D(e)). An
entity is deemed to satisfy this paragraph (d)(4)(i)(A) if the
entity meets the requirements of either paragraph (d)(4)(i)(B) or
(C) of this section, if "50 percent" is applied instead of 40
percent. In addition, an entity may satisfy this paragraph (d)(4)(i)
(A) based on all the facts and circumstances.

(B) Use of tangible property. At least 40 percent of the use of the
tangible property of such entity (whether owned or leased) is within
any low-income community. This percentage is determined based on a
fraction the numerator of which is the average value of the tangible
property owned or leased by the entity and used by the entity during
the taxable year in a low-income community and the denominator of
which is the average value of the tangible property owned or leased
by the entity and used by the entity during the taxable year.
Property owned by the entity is valued at its cost basis as
determined under section 1012. Property leased by the entity is
valued at a reasonable amount established by the entity.

(C) Services performed. At least 40 percent of the services
performed for such entity by its employees are performed in a low-
income community. This percentage is determined based on a fraction
the numerator of which is the total amount paid by the entity for
employee services performed in a low-income community during the
taxable year and the denominator of which is the total amount paid
by the entity for employee services during the taxable year.

(D) Collectibles. Less than 5 percent of the average of the
aggregate unadjusted bases of the property of such entity is
attributable to collectibles (as defined in section 408(m)(2)) other
than collectibles that are held primarily for sale to customers in
the ordinary course of business.

(E) Nonqualified financial property. Less than 5 percent of the
average of the aggregate unadjusted bases of the property of such
entity is attributable to nonqualified financial property (as
defined in section 1397C(e)). Because the definition of nonqualified
financial property in section 1397C(e) includes debt instruments
with a term in excess of 18 months, banks, credit unions, and other
financial institutions are generally excluded from the definition of
a qualified active low-income community business.

(ii) Proprietorships. Any business carried on by an individual as a
proprietor is a qualified active low-income community business if
the business would meet the requirements of paragraph (d)(4)(i) of
this section if the business were incorporated.

(iii) Portions of business. A CDE may treat any trade or business as
a qualified active low-income community business if the trade or
business would meet the requirements of paragraph (d)(4)(i) of this
section if the trade or business were separately incorporated.

(5) Qualified business--(i) In general. Except as otherwise provided
in this paragraph (d)(5), the term qualified business means any
trade or business. There is no requirement that employees of a
qualified business be residents of a low-income community.

(ii) Rental of real property. The rental to others of real property
located in any low-income community (as defined in section 45D(e))
is a qualified business if and 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.

(iii) Exclusions--(A) Trades or businesses involving intangibles.
The term qualified business does not include any trade or business
consisting predominantly of the development or holding of
intangibles for sale or license.

(B) Certain other trades or businesses. The term qualified business
does not include any trade or business consisting of the operation
of any private or commercial golf course, country club, massage
parlor, hot tub facility, suntan facility, racetrack or other
facility used for gambling, or any store the principal business of
which is the sale of alcoholic beverages for consumption off
premises.

(C) Farming. The term qualified business does not include any trade
or business the principal activity of which is farming (within the
meaning of section 2032A(e)(5)(A) or (B)) if, as of the close of the
taxable year of the taxpayer conducting such trade or business, the
sum of the aggregate unadjusted bases (or, if greater, the. fair
market value) of the assets owned by the taxpayer that are used in
such a trade or business, and the aggregate value of the assets
leased by the taxpayer that are used in such a trade or business,
exceeds $500,000. For purposes of this paragraph (d)(5)(iii)(C), two
or more trades or businesses will be treated as a single trade or
business under rules similar to the rules of section 52(a) and (b).

(6) Qualifications--(i) In general. Except as provided in paragraph
(d)(6)(ii) of this section, an entity is treated as a qualified
active low-income community business for the duration of the CDE's
investment in the entity 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 under paragraph (d)
(4)(i) of this section throughout the entire period of the
investment or loan.

(ii) Control--(A) In general. If a CDE controls or obtains control
of an entity at any time during the 7-year credit period (as defined
in paragraph (c)(5)(i) of this section), the entity will be treated
as a qualified active low-income community business only if the
entity satisfies the requirements of paragraph (d)(4)(i) of this
section throughout the entire period the CDE controls the entity.

(B) Definition of control. Generally, control means, with respect to
an entity, direct or indirect ownership (based on value) or control
(based on voting or management rights) of 33 percent or more of the
entity. However, a CDE does not control an entity if an unrelated
person possesses greater control over the entity than the CDE (7)
Financial counseling and other services. The term financial
counseling and other services means advice provided by the CDE
relating to the organization or operation of a trade or business.

(e) Recapture--(1) In general. If, at any time during the 7-year
period beginning on the date of the original issue of a qualified
equity investment in a CDE, there is a recapture event under
paragraph (e)(2) of this section with respect to such investment,
then the tax imposed by Chapter 1 of the Internal Revenue Code for
the taxable year in which the recapture event occurs is increased by
the credit recapture amount under section 45D(g)(2). A recapture
event under paragraph (e)(2) of this section requires recapture of
credits allowed to the taxpayer who purchased the equity investment
from the CDE at its original issue and to all subsequent holders of
that investment.

(2) Recapture event. There is a recapture event with respect to an
equity investment in a CDE if--

(i) The entity ceases to be a CDE;

(ii) The proceeds of the investment cease to be used in a manner
that satisfies the substantially-all requirement of paragraph (c)(1)
(ii) of this section; or

(iii) The investment is redeemed by the CDE.

(3) Bankruptcy. Bankruptcy of a CDE is not a recapture event.

(4) Waiver of requirement or extension of time--(i) In general. The
Commissioner may waive a requirement or extend a deadline if such
waiver or extension does not materially frustrate the purposes of
section 45D and this section.

(ii) Manner for requesting a waiver or extension. A CDE that
believes it has good cause for a waiver or an extension may request
relief from the Commissioner in a ruling request. The request should
set forth all the relevant facts and include a detailed explanation
describing the event or events relating to the request for a waiver
or an extension. For further information on the application
procedure for a ruling, see Rev. Proc. 2001-1 (2001-1 I.R.B. 1) (see
§601.601(d)(2) of this chapter).

(iii) Terms and conditions. The granting of a waiver or an extension
to a CDE under this section may require adjustments of the CDE's
requirements under section 45D and this section as may be
appropriate.

(5) Example. The application of this paragraph (e) is illustrated by
the following example:

Example. In 2003, A and B acquire separate qualified equity
investments in X, a partnership. X is a CDE that has received a new
markets tax credit allocation from the Secretary. X uses the
proceeds of A's qualified equity investment to make a qualified low-
income community investment in Y, and X uses the proceeds of B's
qualified equity investment to make a qualified low-income community
investment in Z. Y and Z are not CDEs. X controls both Y and Z
within the meaning of paragraph (d)(6)(ii)(B) of this section. In
2003, Y and Z are qualified active low-income community businesses.
In 2007, Y, but not Z, is a qualified active low-income community
business and X does not satisfy the substantially-all requirement
using the safe harbor calculation under paragraph (c)(5)(iii) of
this section. A's equity investment satisfies the substantially-all
requirement of paragraph (c)(1)(ii) of this section using the
direct-tracing calculation of paragraph (c)(5)(ii) of this section
because A's equity investment is traceable to Y. However, B's equity
investment fails the substantially-all requirement using the direct-
tracing calculation because B's equity investment is traceable to Z.
Therefore, under paragraph (e)(2)(ii) of this section, there is a
recapture event for B's equity investment (but not A's equity
investment).

(f) Basis reduction--(1) In general. A taxpayer's basis in a
qualified equity investment is reduced by the amount of any new
markets tax credit determined under. paragraph (b)(1) of this
section with respect to the investment. A basis reduction occurs on
each credit allowance date under paragraph (b)(2) of this section.
This paragraph (f) does not apply for purposes of sections 1202,
1400B, and 1400F.

(2) Adjustment in basis of interest in partnership or S corporation.
The adjusted basis of either a partner's interest in a partnership,
or stock in an S corporation, must be appropriately adjusted to take
into account adjustments made under paragraph (f)(1) of this section
in the basis of a qualified equity investment held by the
partnership or S corporation (as the case may be).

(g) Other rules--(1) Anti-abuse. If a principal purpose of a
transaction or a series of transactions is to achieve a result that
is inconsistent with the purposes of section 45D and this section,
the Commissioner may treat the transaction or series of transactions
as causing a recapture event under paragraph (e)(2) of this section.

(2) Reporting requirements--(i) Notification by CDE to taxpayer--(A)
Allowance of new markets tax credit. A CDE must provide notice to
any taxpayer who acquires a qualified equity investment in the CDE
at its original issue that the equity investment is a qualified
equity investment entitling the taxpayer to claim the new markets
tax credit. The notice must be provided by the CDE to the taxpayer
no later than 60 days after the date the taxpayer makes the
investment in the CDE. The notice must contain the amount paid to
the CDE for the qualified equity investment at its original issue
and the taxpayer identification number of the CDE.

(B) Recapture event. If, at any time during the 7-year period
beginning on the date of the original issue of a qualified equity
investment in a CDE, there is a recapture event under paragraph (e)
(2) of this section with respect to such investment, the CDE must
provide notice to each holder, including all prior holders, of the
investment that a recapture event has occurred. The notice must be
provided by the CDE no later than 60 days after the date the CDE
becomes aware of the recapture event.

(ii) CDE reporting requirements to Secretary. Each CDE must comply
with such reporting requirements to the Secretary as the Secretary
may prescribe.

(iii) Manner of claiming new markets tax credit. A taxpayer may
claim the new markets tax credit for each applicable taxable year by
completing Form 8874, "New Markets Credit," and by filing Form 8874
with the taxpayer's Federal income tax return.

(iv) Reporting recapture tax. If there is a recapture event with
respect to a taxpayer's equity investment in a CDE, the taxpayer
must include the credit recapture amount under section 45D(g)(2) on
the line for recapture taxes on the taxpayer's Federal income tax
return for the taxable year in which the recapture event under
paragraph (e)(2) of this section occurs (or on the line for total
tax, if there is no such line for recapture taxes) and write NMCR
(new markets credit recapture) next to the entry space.

(h) Effective date. This section applies on or after December 26,
2001.

PART 602-OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 3. The authority citation for part 602 continues to read as
follows: Authority: 26 U.S.C. 7805.

Par. 4. In §602.101, paragraph (b) is amended by adding an
entry to the table in numerical order to read as follows:
§602.101 OMB Control numbers.

* * * * *

(b) * * *

_____________________________________________________________________

CFR part or section where Current OMB

identified and described control No.

* * * * *
							  
1.45D-1T .................................................1545-1765

* * * * *

_____________________________________________________________________

Robert E. Wenzel
Deputy Commissioner of Internal Revenue.

Approved: December 17, 2001

Mark Weinberger
Assistant Secretary of the Treasury.

SEARCH:

You can search the entire Tax Professionals section, or all of Uncle Fed's Tax*Board. For a more focused search, put your search word(s) in quotes.

2001 Regulations Main | IRS Regulations Main | Home