Mia Thibodeau

Tax Increment Financing (TIF): What is it and how does it affect new developments?

If you have walked in downtown Duluth in recent months, you may have noticed the two large tower cranes swinging impressively overhead.  You may have wondered, how do developers pay for such expensive projects, or why did they choose this location?  Of course, financing for such projects is complex and comes from many sources, but one tool that certain local units of government can use to attract such development is tax increment financing (“TIF”).  Tax increment financing uses the increase in property tax revenue that new development causes to finance costs of the development, such as land acquisition, site preparation or public infrastructure (streets, sewer, water, or parking facilities).

Who can form a TIF District?

The following are the most common types of local units of government that create TIF Districts:

  • Cities
  • Economic Development Authorities or EDAs
  • Housing and Redevelopment Authorities or HRAs
  • Port Authorities

How is a TIF District Created? 

A developer might approach the applicable governmental unit and request the creation of a new TIF district.  Or, a City or EDA may offer TIF to a developer to attract the new development such as a manufacturing facility or commercial office building.  The best-suited projects for TIF funding are those that will increase the property tax base within the district the most.  For example, the new Maurices complex will increase the property tax values in the surrounding area.  Whereas, a project that replaces a run-down apartment building with single family homes would not always increase property tax values.  If the project appears to be a good fit for use of TIF, the governmental unit will undertake the process to create the TIF district pursuant to Minnesota Statutes Section 469.175, which includes 1) drafting a TIF Plan providing details of the project and specifying activities that will take place; 2) identifying the TIF District boundaries; 3) publishing notice in the newspaper; 4) holding a public hearing on the TIF Plan; 5) documenting that the project or development would not have occurred “but-for” the use of TIF and 6) requesting that the county auditor certify the current property tax base (referred to as “net tax capacity”) and the current local property tax rates for the TIF District area.  TIF Districts are located within larger geographic areas referred to as development districts or project areas, which have been separately designated by the governmental authority.

Where does the money come from?

The TIF District creates a funding source for the project because the increase in property tax values from the new construction and improvements result in an increase in property taxes paid.  The amount of the increase to property taxes paid is referred to as the “tax increment” and is dedicated and paid to the governmental unit each year for a period of years along with general property tax payments.  The governmental unit then uses the tax increment to pay qualifying costs such as land acquisition, site preparation and public infrastructure that it has incurred for the project.  Notably, the “tax increment” amount may fluctuate over time as property tax values change as a result of market effects; however, the “tax increment” will not include any increase to property taxes caused by a tax rate increase.  The tax rate is locked at the rate in effect at the time the TIF District is created.

However, a small timing problem exists because generally when a project is constructed, the costs to acquire land, prepare the site and construct infrastructure are incurred at the onset, whereas the “tax increment” is collected at a later time (annually upon payment of property taxes for the life of the TIF District which can range from 8-25 years).  So, does the governmental unit or the developer incur the upfront costs?  One option is for the developer to finance the costs up front with its own funds and the tax increment is used to reimburse the developer as the tax increment is collected (“pay-as-you-go” financing).  Alternatively, the governmental unit may advance money from its own funds such as a development fund or a sewer and water fund (“interfund loans”) to be repaid from the tax increment.  For example, in Duluth, the developer in the Norshor project requested that the City approve an interfund loan.  A governmental unit may also issue bonds to pay the development costs and use the tax increment to pay the bonds back.  Often, the governmental unit will prefer pay-as-you-go financing because it transfers to the developer the risk of the tax increment being insufficient to repay debt or of a legislative change that may affect TIF.

What types of TIF Districts can be created?

Minnesota law permits creation TIF Districts for the following purposes:

  • Economic Development
  • Redevelopment
  • Renewal and Renovation
  • Housing
  • Soils
  • Compact Development

Each type has different restrictions on the length of time tax increments can be collected and the purposes for which the tax increments can be used.  Generally, tax increments cannot be used to finance the construction of government buildings or for the cost of government operations.

What is “pooling”?

Minnesota is unique in that it permits tax increments to be “pooled” or spent outside of a TIF District, but within the broader project area.  The amount of the tax increment that can be “pooled” and spent outside the TIF District is limited to a percentage, depending on the type of TIF District.  For example, Housing Districts are exempt from the percentage limits (so all tax increment can be spent outside the TIF District so long as it is spent within the project areas and on housing development).  Whereas, for a Development District, only 25 percent of the tax increment can be spent outside the TIF District but within the project area.  Notably, administrative costs are deemed to be spent outside of the TIF District, automatically reducing the amount that can be spent outside the TIF District.  Nonetheless, this policy permits the TIF District to benefit a broader area of the community.

As you can see, TIF is a valuable tool for both developers and governmental units to help finance a portion of large projects that may result in more tower crane sightings.

Mia E. Thibodeau is an attorney with Fryberger, Buchanan, Smith & Frederick, P.A., and practices in the areas of municipal law, estate planning and family law.