Daniel Settana – In the wake of the Great Recession, many areas of the country have struggled to recover. In an attempt to drive investment into those areas where economic growth is needed the most, the Opportunity Zone program was created. Beginning as an initiative of the Economic Innovation Group, the Opportunity Zone program was passed by Congress as a provision of the Tax Cuts and Jobs Act.
As of 2018, the Treasury Department had already certified 8,766 areas as opportunity zones. An opportunity zone is a low-income census tract nominated by the Governor of the State where the tract is located and certified by the Treasury Department. In order to capitalize on the Opportunity Zone program, an investor would need to re-invest capital gains in a Qualified Opportunity Fund within 180 days of realizing a capital gain. The IRS defines a Qualified Opportunity Fund as “an investment vehicle that files either a partnership or corporation federal income tax return and is organized for the purpose of investing in Qualified Opportunity Zone property.” A Qualified Opportunity Fund is required to hold at least 90% of the fund’s assets in qualified opportunity zone property.
There are three main benefits for investors who reinvest their unrealized capital gains in a Qualified Opportunity Fund. First, a temporary tax deferral of any capital gains reinvested into a Qualified Opportunity Fund until the earlier date of when the investment is sold or exchanged or December 31, 2026. Second, a step-up in basis for capital gains reinvested in a qualifying fund. The basis increases by 10% if the investment is held for at least five years and an additional 5% if the investment is held for at least seven years. Third, a permanent exclusion from taxable income of any capital gains recognized on the sale or exchange of the investment. In order to receive the permanent exclusion, the investment must be held for at least ten years. However, the permanent exclusion only applies to the gains accrued from the amount invested in the Qualified Opportunity Fund. By offering these benefits, Congress hopes to redirect a portion of the trillions of unrealized capital gains that are currently sitting in stocks and funds to facilitate economic development in distressed communities.
While the program offers significant tax breaks, investors must not lose sight of the overarching goal: to spur economic development. As the New York Times recently pointed out, the program has become susceptible to abuse. Developers have lobbied government officials to get areas designated as opportunity zones at the expense of less affluent areas. There are concerns that the program will mostly benefit projects that were already planned, and the program will lead to gentrification. In order to avoid these abuses, investors should work with community stakeholders to make sure that their investments benefit the respective community situated within the opportunity zone. Additionally, Congress can institute reporting requirements that increase transparency and make sure that investment is funneled to help those the program is intended to help. Overall, Opportunity Zones are a cause worth pursuing, but the program’s fate will depend on its execution and the motives of its participants.