Brokering Tax Credits—A New Approach to Community Development

Many communities have created public-private partnerships to address complex development challenges. The search for solutions to these challenges has led diverse groups to meet and start working together. Often, nonprofit organizations and businesses create new partnerships motivated by state tax credit programs.

Missouri is one of only several states to extensively use state tax credit programs to promote community development. Administered by the Missouri Department of Economic Development, these include the Community Development Bank Tax Credit; Historic Preservation Tax Credit; Capital Tax Credit; Brownfields Tax Credit; Neighborhood Assistance Tax Credit; and Rebuilding Communities Tax Credit programs.

An appealing feature of certain programs is that credits may be sold or transferred, making them valuable to investors who may not have Missouri tax liability.

What Are Tax Credits?

Tax credits are used to induce contributions and investments from the private sector in projects that benefit distressed communities and populations. A tax credit is different from a deduction in that a percent of the value of the contribution or investment is subtracted from the bottom line, reflecting state taxes due by the taxpayer. A deduction occurs in the tax calculation formula and lowers the liability of the taxpayer. Effectively, tax credits allow taxpayers to redirect their state taxes to community or economic development projects approved by the state.

The Challenge

The primary difficulty with tax credit programs is that investors and contributors may or may not choose to receive them. Tax credits allocated to projects may remain unclaimed by investors and contributors. One of the primary reasons that using tax credits to induce private investment is easier said than done is that information about the program takes time to catch on, which creates a lag in program delivery. The lag effect could mean that potential investors do not understand how to make the best use of the programs in their communities. Another problem is that there is no tax credit market to provide a place where buyers and sellers come together to trade.

One Solution

A bold solution to the challenge of making the best use of tax credit programs is the Missouri Tax Credit Clearinghouse, a subsidiary of St. Louis-based Mercantile Community Development Corporation. Approved to operate by the Office of the Comptroller of the Currency in late 1998, the Clearinghouse has become the first entity in the nation to start brokering tax credits.

The Clearinghouse works only with state tax credits that may be sold or transferred between parties. Kathy Bader, president of the Mercantile Community Development Corporation, estimates that the primary activity of the Clearinghouse, so far, has been in facilitating buying and reselling tax credits. "Many people want to invest in community development projects, but they don't understand how tax credits work or which projects are a good match for them," she said. "On the other hand, some companies and nonprofits have more tax credits than they can use. The Missouri Tax Credit Clearinghouse brings them together."

The Hotel Governor in downtown Jefferson City, Mo., had been idle for more than 10 years. Currently, it is being renovated as an office building. Until state brownfields and historic preservation tax credits became available, the project was not doable. Then, Mercantile made a $5-million equity investment and a $7.5-million construction loan for the renovation. The bank will recoup its investment through a combination of federal and state tax credits. Since the bank has enough tax credits from other projects to claim against its own liabilities, however, it will sell the credits from this project to investors. "Without the various tax credits, we wouldn't have been able to finance this project," Bader said.

In the future, the Clearinghouse plans to expand activities into providing financial advice, deal structuring, and managing transactions, as well as continuing to broker or bring together investors and developers.

Subscribe

Keep up with what’s new and noteworthy at the St. Louis Fed. Sign up now to have this free monthly e-newsletter emailed to you.

Subscription Options


Additional Fed Publications

Fed in Print: An index of the economic research conducted by the Fed.

 

2015 Federal Reserve System
Community Development
Research Conference