Opportunity Zones are the result of the new community development program established by Congress in the Tax Cut and Jobs Act of 2017 to foster investment in low-income and urban areas. Within the Tax Cut and Jobs Act of 2017 lies the Investing in Opportunity Act, the first new national community investment program in over 15 years. The community reinvestment tool aims to use tax incentives to drive long-term investments to rural and low-income urban communities throughout the nation by encouraging the estimated $6.1 trillion of unrealized private gains held by U.S. households to be invested in census tracts that have been historically low-income. This new legislation has the potential to be the largest economic development program in the United States by providing for a temporary deferral of tax on capital gains, a reduction in the amount of capital gains tax that must ultimately be paid, and tax-free appreciation in special investment vehicles known as “qualified opportunity zone” funds, or opportunity funds.
New Markets Tax Credit (NMTC) Program, Low Income Housing Tax Credit (LIHTC) Program, and other existing tax credit programs are limited in supply and subject to Congressional approval each year. The tax credit system limits the number of credits issued annually, which in turn limits the number of investors able to participate, and ultimately the amount of money that can be invested into development. Opportunity zones, however, are regulated through two Internal Revenue Code sections that remove any restriction on the number of opportunity funds possible. The opportunity zone program is less constricting, less costly, and less contingent on government agencies to operate. Opportunity funds can self-certify, eliminating the approval needed from the U.S. Treasury Department and causing the funds to be managed entirely in the private market. The administration of the funds is handled entirely by fund managers rather than government agencies or investors. There is no cap on the amount of capital that can be invested into qualified Opportunity Zones through the program and no arbitrary limit on the extent to which the program may help reshape downtrodden communities.
Opportunity zones are created with a nomination and designation process according to the act. Governors of each state and territory are authorized to nominate qualified census tracts for opportunity zone designation within their jurisdiction. Census tracts must meet the low-income requirements defined by U.S. Internal Revenue Code Section 45D(e):
- A poverty rate of at least 20%; or
- A median family income of:
- No more than 80% of the statewide median family income for census tracts within non-metropolitan areas.
- No more than 80% of the greater statewide median family income or the overall metropolitan median family income for census tracts within metropolitan areas.
According to the Brookings Institute, 57% of all neighborhoods in America could be included for consideration as opportunity zones using the above requirements. The U.S. Treasury assessed each tract and certified over 8,700 tracts, equating to 12% of all census tracts in the United States. Governor Greg Abbott nominated 628 census tracts that were approved.
The capital gains tax incentives can be received immediately as well as over the long term. Investors create what is called an opportunity fund to make investments rather than purchasing tax credits through a secondary market. A qualified opportunity fund is a U.S. partnership or corporation that intends to invest at least 90% of its holdings in one or more qualified opportunity zones. As previously mentioned, each opportunity fund is responsible for ensuring that they abide by the guidelines of the Opportunity Program in order to offer tax incentives to its investors. There are restrictions to the types of investments in which an opportunity fund can invest; partnership interests or stock ownership must be in businesses that conduct most or all of their operations within an opportunity zone, or property such as real estate located within an opportunity zone. The types of real estate investments allowed by the program are also limited to ensure that the communities are improved with each investment. Opportunity funds can invest in either the construction of new buildings or the substantial improvement of existing buildings. If an opportunity fund invests in the improvement of an existing building, it must invest more in the improvement of the building than it paid to purchase the building. Whether the building is constructed from the ground up or improved, the development of the building must be completed within 30 months of purchase.
To encourage long term investment, U.S. investors can receive a permanent exclusion from taxable income of capital gains when an investment is held for at least 10 years. If an investor reinvests a capital gain into an opportunity fund, they can defer and reduce their tax liability on that gain as long as Capital gains are invested in an opportunity fund within 180 days from the date they are realized, and investments are made by end of 2019. Tax on the gain invested in the opportunity fund is deferred until whichever comes first: the date a taxpayer sells its interest in the fund or Dec. 31, 2026. When ownership is held at least five years, 10% of the gain invested is excluded from the tax owed upon the sale of the taxpayer’s interest in the fund (or 2026, whichever is earlier). If the ownership interest is held for at least seven years, an additional 5 percent of the invested gain is excluded from the tax owed (for a total of 15 percent) and ownership interest held in an opportunity fund for at least 10 years allows appreciation in the investment to be completely tax-free when the taxpayer sells its interest.
A majority of the opportunity zones in Texas are located in Harris County, which has 105 designated zones. These zones were selected in March of 2018, shortly after Hurricane Harvey devasted the coast of Texas, and in particular, much of Harris County, which may be have played a factor when Gov. Abbott began his selections. Austin has 21 opportunity zones, primarily located east of I-35. Dallas County has only 18 tracts designated as opportunity zones. There are few plans in the works as of now for the zones in Austin, and many public entities feel unsure about their benefits. Some believe opportunity zones, in general, are bad news, causing displacement and gentrification. They have called for policies to be set in place to prevent this. An opportunity zone on East Riverside is slated to become an apartment complex, breaking ground in the second quarter of 2019 and has several efficiency studio units planned.
DISCLAIMER: ECR nor the author of this article is a CPA and do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.