In December of 2017, when President Trump’s thousand-page Tax Cuts and Jobs Act went into effect, it included a short, unassuming piece of bipartisan legislation that quietly flew under the radar.
It was no surprise that the Investing in Opportunity Act didn’t receive much attention, initially, surfacing at a time when the nation was gripped by more intriguing political news. But now, over a year later, it is finally receiving the buzz it deserves.
The Opportunity Zone program offers generous tax advantages that some experts project will deliver enormous benefits to private-sector investors, and promising economic growth potential for low-income communities.
Using investment vehicles called Opportunity Funds, investors can defer capital gains tax for up to ten years—and potentially eliminate capital gains tax altogether. The key will be to reinvest capital gains, which are profits accrued from the sale of an investment, into certain qualified census tracts, which are now designated by the United States Treasury as Opportunity Zones.
The proposed legislation emerged in 2017 out of a collaboration between South Carolina Republican Senator Tim Scott and New Jersey Democratic Senator Cory Booker. Both represent hard-hit urban and rural districts in their respective states, and both wanted to find a way to bring private sector dollars into these distressed communities, noting they have been largely overlooked since the country’s recovery from the Great Recession.
While pockets of America have seen explosive revitalization over the last decade—parts of Pittsburgh, Chicago and Detroit, among others—plenty more, like those surrounding Milwaukee, Norfolk, Virginia, and Hidalgo, Texas, remain blighted, with high unemployment and poverty rates among their residents and boarded-up windows on the shops lining their Main Streets.
So Senators Booker and Scott needed an appealing investment vehicle that would prompt companies to consider opening businesses in these communities and incentivize private investment in commercial real estate there in order to create jobs.
Thus, with the help of policy experts, Opportunity Zone investing was born.
How Were Opportunity Zones Identified?
In the Spring of 2018, governors across the US were given the task of identifying which census tracts in their states would qualify as Opportunity Zones. Mayors and other city officials everywhere got to work nominating locales they believed ought to be included. Ultimately, up to 25% of each state’s low-to-moderate-income census tracts were eligible for official Opportunity Zone (OZ) designation.
Using available data extracted between 2011 and 2015, census tracts that could be considered had to meet the Low Income Community (LIC) requirement of having a median family income at or below 80% of Area Median Income (AMI) or a poverty rate of 20% or greater, according to Policymap.com.
Further, they explain that, since the OZ program’s inception, up to 5% of census tracts with a high rate of transience and overall low population have also been made eligible, allowing for more areas to be included regardless of income level, as long as they have a median family income that does not exceed 125% of their low-income neighbors.
For perspective, the average poverty rate in Hidalgo, Texas, is currently at 28.2%, according to Data.usa, making the need for economic investment there dire. In Norfolk, Virginia, where median family income hovers around $45K, the rest of that state averages a much higher annual wage ($65K). Opportunities to invest in places like these would narrow the gap between them and their thriving neighbors.
To date, more than 8,700 census tracts have been identified across the US as qualified Opportunity Zones. Download the United States Department of the Treasury’s complete list of them here.
Three Major Benefits Available To Opportunity Zone Investors
Investing in an Opportunity Zone yields three types of attractive benefits: 1) capital gains tax deferment, 2) capital gains tax reduction, or “trimming,” and 3) capital gains tax elimination. The level of benefit investors can take advantage of depends upon several distinct factors.
Profits from the sale of an existing investment will accrue tax. But using those profits, or capital gains, to reinvest in a qualified Opportunity Zone gives investors a deferment on paying those capital gains taxes, either until that new interest is sold or until the year 2026, whichever comes first.
What’s even better is that investors could see those capital gains tax payments reduced, or trimmed, by 10% or even 15%.
1. How to Reduce Capital Gains Tax Payments By 15%
To get a 15% reduction in paying capital gains tax from the sale of old property, an investor must use profits from that sale to reinvest in an OZ within 180 days of that sale. Further, they must finalize that new, OZ transaction before the end of 2019 and hold onto that investment through 2026. This fulfills the new tax code’s seven-year requirement.
2. How to Reduce Capital Gains Tax Payments By 10%
To get a 10% reduction in paying capital gains tax on the sale of old property, an investor must use profits from that sale to reinvest in an OZ by 2021, and they must hold onto that investment for a full five years, or until 2026.
3. How to Get Capital Gains Tax Eliminated (for the new investment only)
In order to see a complete elimination of capital gains tax payments, investors can purchase a new investment in a qualified Opportunity Zone (using their previous capital gains) but they must hold that interest for ten years or longer. The capital gains tax is eliminated on the future sale of the investment made with an investor’s initial capital gains investments. In other words, one would still have to pay deferred and potentially trimmed capital gains tax on their old investment in 2026, but when that Opportunity Zone investment is sold, if it were held for ten years or longer, no capital gains tax would be due.
It is worth noting that these capital gains tax adjustments mentioned above will actually come in the form of an increase in the basis of the investment, so the actual amount of reduction could differ if other factors occur, including any change in tax rates.
Adhering to these five, seven and ten-year benchmarks is intended to give low-income communities ample opportunity to begin to flourish. But, given that these are some of the most generous tax incentives this country has seen in the last 25 years, they will likely be a boon for private investors, too.
Concerns exist among some, however, who worry the program could inspire hungry developers to abuse the benefits available and wind up displacing residents who may not be able to afford to remain in these newly revitalized neighborhoods.
While pundits acknowledge that some fundamentals of how the program will work have yet to be determined, the potential for massive economic recovery among those living in hard-hit communities could be exponential.
