A new program created through the Tax Cuts and Jobs Act, passed at the end of last year, seeks to bring investment to distressed communities across the United States. The Opportunity Zone program would provide investors with a tax benefit for investing in ‘Opportunity Funds’ that would direct capital to businesses and real estate development in our nation’s most economically challenged communities.
Economic Innovation Group (EIG) released a concept paper with this idea back in 2015. Their analysis showed that there are over $2 trillion in unrealized capital gains held by investors. These “passive” investments are held in stocks and mutual funds, and have yet to be sold– so their value is only on paper. Once sold, when the gain on the investment is “realized,” the profits are taxed as capital gains.
Under the Opportunity Fund program, investors would receive a tax benefit for reinvesting these unrealized gains into Opportunity Funds that invest in economically distressed areas. Opportunity Funds would be created by pooling together capital from various investors, such as banks, hedge funds and others, with the aim of investing within Opportunity Zones. Governors of each state and territory, and Washington DC, would designate low-income and high-poverty areas as Opportunity Zones, in which investors could provide equity investments (an ownership stake) in small business startups, business expansion, or real estate development.
The longer an investor stays invested in an Opportunity Fund, the more of a tax benefit they will receive. LISC provides a helpful chart their fact sheet about this program, which shows that the maximum benefit would be achieved after 10 years. At that point, investors would defer payment of the existing capital gains until December 31, 2026 (or the date that the investment is sold or exchanged), pay 85% of their taxes on existing capital gains, and pay no taxes on any capital gains earned from the Opportunity Fund investment.
There are still steps that need to be taken before this program can be implemented. First, governors have until March 22,2018 to identify their states’ Opportunity Zones. The zones will then be certified by the US Department of Treasury and will remain in effect for ten years. Treasury will also propose a set of rules for implementing the program, and will provide 30 to 60 days for public comment on these rules. Enterprise Community Partners estimates that the implementation of this program will not begin until the end of 2018 or the beginning of 2019.
As these steps progress it is critical that governors first ensure that the selected Opportunity Zones include those areas that are truly economically distressed, including those that are designated as “severe economic distress.” This will ensure that new investments are targeted to areas that have suffered from disinvestment, and not end up subsidizing investments that would have occurred anyway.
The Opportunity Zone program is the first major effort to spur investment in underserved communities in over a decade. It has a great potential to steer capital toward community revitalization where it is needed most. More details will emerge as Opportunity Zones are designated and the rules are established.