Investing in distressed communities brings incentive tax benefits.
The Tax Cuts and Jobs Act of 2017 included a provision that, until recently, has garnered little attention. Commonly referred to as the federal opportunity zone program, this program, still in its infancy, provides tax benefits to those who invest in qualified opportunity zones - low-income Census tracts nominated by each state.
To qualify as an opportunity zone, the tract must be designated as a low-income community under Section 45D(e) with one of the following: a poverty rate of at least 20 percent; or with a median family income that does not exceed 80 percent of area median income; or the tract must be contiguous with a designated low-income community and the median family income does not exceed 125 percent of the median family income of the contiguous designated low-income community.
Opportunity Zone Incentives
Opportunity zones were created to stimulate economic development and job creation in distressed communities. The program provides three federal tax incentives to encourage investment in these areas:
- Gains reinvested directly in an opportunity zone, or through an investment vehicle known as a qualified opportunity fund, are deferred until the earlier of either the sale of the investment or Dec. 31, 2026.
- The basis of any investment in a qualified opportunity fund held for at least five years is increased by an amount equal to 10 percent of the amount of gain deferred under the opportunity zone program. If the investment is held for at least seven years, there is an additional 5 percent basis increase.
- If a qualifying investment is held for at least 10 years, any built-in appreciation during the life of the qualifying investment is excluded from income.
To be eligible for the benefits associated with investing in qualified opportunity zones, gains from prior investments must be rolled directly into a qualified opportunity zone or qualified opportunity fund within 180 days of realization. Given its potentially significant tax benefits, those with recent substantial gains may want to consider participating in the opportunity zone program.
The market largely will dictate which qualified opportunity zone... is developed.
This program is different from previous efforts to encourage economic development in low-income communities in that it is less directly dependent on federal subsidies. Also, there are no assurances that a qualified opportunity zone designation will attract investment into a particular community. Instead, the market largely will dictate which qualified opportunity zone and type of qualified opportunity zone business property are developed.
These properties generally must be new construction or substantially improved, meaning rehabilitation costs must exceed the cost of acquisition during the 30 months following acquisition. In addition, golf or country clubs, racetracks and gambling facilities, suntan facilities, massage parlors, and liquor stores are not eligible for qualified opportunity zone business property designation and investment, and a qualified opportunity fund may not invest in mortgage pools or merely debt investments.
The Department of Treasury released proposed regulations and other largely taxpayer-favorable guidance in October 2018, which clarified issues such as treatment of working capital; self-certification of a qualified opportunity fund; the substantial improvement requirement in an acquisition/rehabilitation of an existing building; and the original use of land.
Final guidelines and regulations are pending. Industry leaders most likely will propose comments to Treasury for how to address a number of factors, including the type of restrictions that might be imposed when raising funds; anti-abuse rules; safe harbors from penalties for failing to satisfy asset-test requirements; the meaning of substantially all as set forth in the original statute; causes for decertification of a qualified opportunity fund; back-end transactions; and to combine the incentive with tax credits.
Following the initial guidance from Treasury, potential investors now are seeking investment in qualified opportunity funds. The Economic Innovation Group, a think tank founded by Napster's Sean Parker, estimates that as much as $6 trillion of capital gains will be eligible for investment. Numerous funds throughout the U.S. are raising capital and locating and entitling qualified opportunity properties to be acquired and developed. According to a recent article in Barron's, Cresset Capital Management has $1 billion of real estate deals in the pipeline nationwide. In Arizona, several funds were created by various real estate developers and fund managers, including Caliber, True North, TransEquity, and Culdesac.
Lists and maps of qualified opportunity zones, as well as additional resources, are available at www.cdfifund.gov.
View CCIM Institute's recent webinar, "Capitalizing on Opportunity Zones and Section 199A":