Metro Pulse/Insights/Federal Tax Credits

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by Joe Sullivan

Along with incentives from the city, federal tax credits are making a big contribution to center city redevelopment. That contribution could get bigger under a new program due to be activated by the end of the year.

The residential renovations that are transforming the 100 block of Gay Street would not have been feasible without the Historic Tax Credit that allows 20 percent of the cost of restoring historic buildings to be offset against federal income taxes. The same goes for developer Sam Furrow's renovation of the downtown post office building that aims at relocation of the state Supreme Court from a prospective convention center hotel site. The tax credits on the Sterchi Building, the Emporium, and the post office building alone figure to total about $4 million.

While the credits go to a building's owner and are spread over five years, as a practical matter the owners don't use the credits themselves but rather sell them to banks and collect their full entitlement up front. It's almost as if the fine print of the Internal Revenue Code begets a cash advance that enables developers to collect a crucial portion of the money needed for historic building restoration.

From the bank's standpoint, their payments for the credits represent an investment. Since they are virtually assured of generating enough taxable income to apply the credits as a dollar-for-saving on their taxes, the banks are also assured of a return on their investment. In order to get a rate of return that also reflects the fact the tax savings won't be fully realized for five years, up front payments by the banks might only amount to 85 cents, or so, on the tax credit dollar (i.e. 85 percent of the full amount of the tax credit). But that's still enough to cover close to 20 percent of building renovation costs.

An even more lucrative type of tax credit could prove pivotal in financing everything from commercial development in the blighted Five Points area to a new convention headquarters hotel. It's called the New Markets Tax Credit (NMTC), and it provides a 39 percent tax credit over seven years on investment in businesses in low income census tracts. The tracts that qualify are comparable to those eligible for federal grants under the Empowerment Zone (EZ) program under which Knoxville was due to get $100 million over 10 years. But the Bush administration is curtailing EZ grants while promoting tax credits as a preferable way to promote economic development and employment in targeted areas, and Knoxville's center city qualifies.

Unlike most tax credits, which are available on an open-ended basis to anyone who is eligible, the NMTC program sets a $2.5 billion ceiling on the amount available each year. The Treasury Department is expected to come out with its initial round of NMTC tax credits by year-end. Eligibility is limited to what are termed Community Development Entities (CDEs) that have been formed for the specific purpose of making investments that adhere to the program's criteria.

The only CDE in Knoxville is Resurgence Knoxville, which was formed by developer Lawler Wood (Oak Ridge-based Technology 2020 has the one other CDE in the area). Resurgence Knoxville is seeking $125 million in NMTC allocations for projects that range from commercial developments in Five Points and Mechanicsville to a Baptist Hospital hospice, a new campus for South College, and a convention headquarters hotel. A presumed $5 million investment in a neighborhood commercial center in Five Points anchored by a grocery store is the top project on the list, while a presumed $75 million for a hotel is by far the largest.

Since the Treasury Department has received $25 billion in NMTC applications that are competing for its $2.5 billion in first year allocations, Resurgence Knoxville's chances of initially getting anything approaching the $125 million sought appear remote. But even if they only served as a Five Points catalyst for starters and helped facilitate financing a hotel in some longer run, NMTC could prove a major boon to the community.

Like Historic Tax Credits, the NMTC tax credits would be sold to banks for an up front payment. Because the full 39 percent credit can only be realized over a longer period of time (seven years), their discounted present value is estimated to be on the order of 30 percent of the amount of an investment. In the case of Five Points that could cover $1.5 million of the $5 million cost a development, leaving $3.5 million to be obtained from loans or other sources-which won't come easily. But in the view of Lawler Wood's Jon Lawler, "when you mix in the power of NMTC, it makes you very optimistic about the feasibility of the project."

Already, the city has committed $600,000 to acquire a site encompassing the long-gone Cas Walker store near the intersection of McCalla Avenue and Martin Luther King Boulevard. Acquisition is contingent on environmental studies presently being overseen by Knoxville's Community Development Corp. KCDC's Dan Tiller reports that "we've got to be sure there's no contaminated soil, but based on phase one of our study I don't foresee any major problems." If the city proceeds, it might retain ownership of the property to keep it off the tax rolls and make it available to a competitively selected developer on a low cost basis.

A successful operator of small grocery stores, Jim Wood, and the owner of a convenience store already located on the Cas Walker site, John Davis, are understood to be collaborating on a grocery store intended to anchor a center with several smaller shops. Wood owns the Village Market in Gettysvue and 26 similar markets spanning a three-state area. A business loan pool drawn from the $22 million in Empowerment Zone grants the city received before the Bush Administration put the clamps on them could be another source of funding. But the Partnership for Neighborhood Improvement, which administers the EZ money, is committed to a diverse array of projects prioritized by advisory councils in each of six zones of the city. "Our business loans are typically in the $35,000 to $50,000 range, and a project on the scale of Five Points would be beyond our reach, "says PNI's executive director, Terrence Carter.

Where a convention hotel is concerned, a preliminary Lawler Wood analysis suggests that use of NMTC could provide much lower-cost financing than the avenue identified by the city's hotel consultant, Annapolis-based Donald Hunter. Hunter has been pointing the city toward financing a hotel with tax-exempt revenue bonds. But the Lawler Wood analysis indicates that an NMTC approach could reduce borrowing cost on a $50 million hotel by almost $1 million a year, about a third lower than the tax-exempt bond approach. A reduction of this magnitude could represent a make-or-break difference in the viability of a new hotel. Of course, that's all contingent on getting sufficient NMTC allocations—which is a big if.

NMTC is just one of several new types of tax credits intended to boost businesses and employment in defined low-income areas. Another would allow a business a credit of up to $3,000 a year for each employee who lives and works in such an area. This, too, could mean significant savings to a new convention hotel, and for that matter to Knoxville's existing downtown hotels and many other businesses large and small.

Whether all of these programs represent a boon or a boondoggle is a matter for debate. This columnist isn't going to venture an opinion on the equitability or efficacy of using the tax code as a stimulus, except to say that as long as these incentives are available, let's take full advantage of them.