Regular readers of Business View Magazine know that we often report on economic revitalization efforts in American and Canadian towns, cities, and counties. Here in the U.S., a recently promulgated federal initiative, the Opportunity Zone Program, has increasingly been cited by the administrators we talk to as a new and provocative tool that they hope will add heft to their ability to infuse needed funds into their communities.
An Opportunity Zone (OZ) is a designation created by the Tax Cuts and Jobs Act of 2017, allowing for certain investments in low-income urban and rural communities, nationwide. The purpose of the program is to put capital to work that would otherwise be locked up due to an asset holder’s unwillingness to trigger a capital gains tax on their existing assets after cashing them out.
Opportunity Zones provide a tax incentive for investors to re-invest their unrealized or accumulated capital gains into dedicated Opportunity Funds. Funds can then be used to finance commercial and industrial real estate, housing, infrastructure, and existing or start-up businesses. For real estate projects to qualify for Opportunity Fund financing, the investment must result in the properties being “substantially improved.” The fund, which can include capital gains from multiple investors and invest in multiple projects, can then offer investors a trifecta of attractive tax breaks, so long as it can prove it has been consistently active in the redevelopment and maintenance of the project.
The longer a fund holds on to the project, the more tax obligations it will be able to erase. For instance, a five-year investment will grant a fund the opportunity to defer 10 percent of capital gain taxes on the original asset, while a seven-year investment means 15 percent of the capital gains won’t be taxed. On top of that, an opportunity fund that holds onto the replacement asset for at least 10 years will allow an investor to avoid paying capital gain taxes altogether on that particular sale. According to one analysis, the incentives could increase an investor’s returns by 70 percent.
An investor may exclude 10% of the deferred capital gain by investing in an Opportunity Fund by the end of 2021, in order to meet the five-year holding period. An investor will need to invest in an Opportunity Fund by the end of 2019 in order to meet the seven-year holding period and be able to exclude 15% of the deferred capital gain.
The concept of Opportunity Zones was originally introduced in a 2015 paper, “Unlocking Private Capital to Facilitate Economic Growth in Distressed Areas,” to help address the persistent poverty and uneven recovery that left too many American communities behind, especially after the Great Recession. The idea has since been championed by a wide-ranging coalition of investors, entrepreneurs, community developers, economists, and other stakeholders.
The first OZs were designated in April 2018. They are places in the U.S. where over 31 million people live and work, covering downtown, industrial, suburban, and rural areas. There are more than 8,764 zones in the 50 states, and five U.S. possessions, including American Samoa, Guam, Northern Mariana Islands, Puerto Rico, and the Virgin Islands. According to census data and analysis, in the average OZ, the median household income is $33,345, the poverty rate is 31.75%, the unemployment rate is 13.41%, and 56% of residents are people of color. Over 75% of OZs are in metropolitan areas; 294 OZs contain Native American lands.
As yet, it’s too early to determine whether or not Opportunity Zones will help revitalize impoverished areas – its intended goal. Critics of the program believe that rather than helping to build low-income housing, for example, Opportunity Funds will end up financing things like high-end apartments and hotels in areas that already attract a lot of investment capital.
Boosters of the program, though, believe that OZs will be transformative for communities that haven’t had access to capital and haven’t participated in the economic recovery of the last several years. As the program plays out over the next 10 years — Opportunity Zone designations expire Dec. 31, 2028 – we will be watching to see if the results bear out the promise.