[Federal Register Volume 66, Number 247 (Wednesday, December 26, 2001)]
[Rules and Regulations]
[Pages 66307-66314]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-31528]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8971]
RIN 1545-BA49


New Markets Tax Credit

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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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 Sec. 1.45D-1T, 
see Sec. 1.45D-1T(h).

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

SUPPLEMENTARY INFORMATION:

Paperwork 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 
(Pub. L. 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.

[[Page 66308]]

    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

[[Page 66309]]

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.

[[Page 66310]]

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:


Sec. 1.45D-1T  New markets tax credit.

    (a) Table of contents. This paragraph lists the headings that 
appear in Sec. 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;
    (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

[[Page 66311]]

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 Secs. 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).

[[Page 66312]]

    (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) of this section 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.

[[Page 66313]]

    (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 
Sec. 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

[[Page 66314]]

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 Sec. 602.101, paragraph (b) is amended by adding an 
entry to the table in numerical order to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                *         *         *         *         *
1.45D-1T...................................................    1545-1765
 
                *         *         *         *         *
------------------------------------------------------------------------


    Approved: December 17, 2001.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Mark Weinberger,
Assistant Secretary of the Treasury.
[FR Doc. 01-31528 Filed 12-21-01; 8:45 am]
BILLING CODE 4830-01-P