Seizing the Opportunities in Opportunity Zones

The ‘Great Recession’ of the late 2000s and early 2010s left scars; approximately 25 percent of U.S. counties have yet to regain the level of economic activity they enjoyed prior to it. Opportunity Zones, a product of the Tax Cuts and Jobs Act (TCJA), which passed in December 2017, are part of the federal government’s response, incentivizing businesses, developers and private investors, to infuse capital investment into challenged communities for an extended period of time.

Simply put, Opportunity Zone locations are created from census tracts. As of Spring 2018, there are 8,500 census tracts nationwide designated by the governors of all 50 states, U.S. territories, and District of Columbia as Qualified Opportunity Zones. These tracts are based on income criteria set forth by the federal government. They generally consist of 1,200-8,000 people, are both rural and urban, with income levels ranging from low to moderately low-income.
Businesses, community developers, and individual investors with capital gains to invest are joining together to create investment vehicles, called Opportunity Funds, to take advantage of this new program. A fund can be set up as a partnership or a corporation and must invest 90 percent or more of its assets in qualified Opportunity Zone property. This investment must be there for 5-10 years or more in order for the investors to accrue certain financial benefits, those being:

  • deferral of capital gains taxes due
  • step-up in basis on those capital gains (e.g. 10% for 5 years, 15% for 7 years)
  • tax-free capital gain on any appreciation in Opportunity Zone asset value over the life of the investment (only applies to gains accrued after investment in the Qualified Opportunity Fund)
One challenge for Opportunity Fund managers lies in locating the Opportunity Zone that best fits the types of investments they want to make. There are several investment options, such as capital equipment, building rehabilitation, and land development. For individual investors, an additional challenge can be connecting with the right Opportunity Fund.

Given the program’s newness, its landscape is just now starting to take shape. Opportunity Funds have only recently begun forming and there is still work underway to fully understand their complexities and to formulate strategies for gauging relative risk and returns in particular zones.

By way of example, the census tracts upon which Opportunity Zones are defined were created and labeled as low or moderately low income (as indicated in the 2011-2015 American Community Survey, ACS). After three-to-seven years, some designated zones have recovered economically. That means while they currently do not meet the income-level criteria set forth by the government, they still qualify based on their label per the ACS.

The uncertainty illustrated there presents an opportunity for brokers to advise clients of their options. With expertise in site selection, a consultant can perform feasibility studies, analyze critical location factors (e.g. infrastructure, labor, regulatory considerations), and identify associated state and federal economic incentives. These tactics help the client reduce the universe of 8,500 opportunity zones down to the most attractive 25 based on investment strategy.
It’s too early to talk about an established track record for Opportunity Zones. Ultimately, judgment on the program’s short-term efficacy will be rendered in 30 months. At this time the fair market value of any improvements made will be determined and their impact in the community analyzed. That impact – hopefully positive – on people and blighted communities is something we should not lose sight of. Economic development is really nothing more than elevating communities. In the end, those communities should be the real winners.
Brooke Perez
Managing Director, Economic Incentives

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