Navigating the Land of OZ: Understanding Opportunity Zones and Opportunity Funds
Flying under the radar in the 2017 tax reform package was a sleeper provision that authorized the designation of “opportunity zones” and the creation of “opportunity funds.” This versatile program has the potential to stabilize and revitalize distressed neighborhoods and surrounding communities by unlocking private investment capital through a series of tax benefits.
The provision allows individual and corporate investors to defer capital gains tax until 2026 if those gains are reinvested into new construction or major rehabilitation of projects in economically depressed areas via designated opportunity funds. If held for five years, the original amount of capital gains tax due is reduced by 10%; if held for seven years it is reduced by an additional 5%. If the investment is held for at least ten years, gains on the invested amount accrue tax-free.
Estimates suggest that $6.1 trillion of unrealized capital gains is held by American households ($3.8 trillion) and American corporations ($2.3 trillion). Getting to that capital will be a bit trickier. Much of the money is disaggregated across individual accounts managed across myriad institutions and platforms.
At least 90 percent of the assets in such funds must be invested in government-designated low-income zones. The governor of each state was able to designate up to 25 percent of the state’s low-income communities (LIC) as opportunity zones. Up to 5 percent of the designated zones could be contiguous to LIC tracts. The zones are designed to be in areas that have a poverty rate of at least 20 percent or that have a median income that does not exceed 80 percent of the metropolitan area’s median income. The final designations were made in spring 2018. In total, 8,700 opportunity zones were chosen by state governors and approved by the U.S. Department of the Treasury. These zones range from a few blocks in large metro areas to entire municipalities in some rural states. The Treasury Department has indicated that no additional opportunity zones will be added.
The expectation is that the added tax incentives will make investment in these disadvantaged areas just a little more enticing and add another option to the capital stack. Concerns exist that the investment capital that may come flooding in also has the potential to push out residents and achieve value primarily for investors. It is expected that states and local communities will provide guidelines to ensure that the objectives of affordable housing, strong neighborhoods, and vibrant, diverse, and sustainable communities are met.
As of the third week in August 2018, final rules from the Treasury Department were still pending.