Opportunity Zones: The Basics
WRITTEN BY: Alex Hurley with contributions from Rhonda Binda
Venture Smarter’s Alex Hurley breaks down the basics of Opportunity Zones and the GAIIN Act. Subscribe for updates and information about an upcoming webinar discussing the topic.
Within the "Tax Cuts and Jobs Act" (commonly known as the Republican Tax Plan), which was signed into law by President Trump at the end of 2017, is a relatively unknown provision that has the potential to entirely reshape investment in place-based economic development programs across America for the next decade or more. This particular clause of the tax plan, previously existing as independent legislation called the "Investing in Opportunity Act", provides guidance on the creation of “Opportunity Zones” within certain census tracts in U.S. states and territories that are lagging behind in development and outlines a tax-incentive framework designed to attract private investors to reinvest capital gains into projects in these "O-Zones" in order to drive local economic development initiatives. Initial investments into O-Zones could begin as early as the fourth quarter of 2018, pending final rules and guidance from the Treasury Department and the Internal Revenue Service.
Developing Opportunity Zones:
After the comprehensive tax legislation was signed into law, the Treasury Department was responsible for laying the groundwork for Opportunity Zones to become a reality. They first identified eligible census tracts around the country. To qualify, a tract had to have a poverty rate of greater than or equal to 20% or a household income that is less than 80% of the surrounding area. Governors were then tasked with cutting down the list of eligible tracts in their jurisdiction by 75%. The remaining 25% of census tracts, which can be viewed in a nationwide map here, were then given the official designation of "Opportunity Zone". There are approximately 8,700 O-Zones in total, which are home to 35 million people. Over three-quarters of O-Zones are in metropolitan areas and 294 O-Zones contain Native American lands. Households in O-zones have lower home values, lower homeownership rates, and higher levels of renter cost burden. There exists significant overlap of O-Zones with the affordable subsidized housing stock and other federal place-based programs.
How Opportunity Zones Work:
Investment in O-Zones will take place through investment vehicles called "Opportunity Funds". Individuals and corporations alike can invest in O-Funds, which must allocate 90% of their assets into O-Zone projects. The available asset classes for Opportunity Funds are broad and flexible at this time. Options include affordable housing, real estate, infrastructure, transit, brownfield redevelopment, startup support, and innovation districts.
The draw to investors comes from the tax-incentive framework included in the legislation. Investors who sell assets have 180 days to invest their taxable capital gains into an Opportunity Fund. Tax on the original reinvested gain isn't due until 2026, and the taxable gain is cut by 15%. Meanwhile the new opportunity investment grows tax-free, like a Roth IRA, provided it's held for at least ten years. This link provides a helpful infographic to explain the investment opportunity further.
It has been identified that local leadership will be key for successfully attracting investment to O-Zones. Many localities are exploring options to create public-private partnerships and nonprofits in order to help regulate and shape investments from Opportunity Funds. A helpful tool to use in order to take a closer look at Opportunity Zones in your area is called Opportunity360, which was created under the umbrella of the Enterprise Opportunity Zones Platform. Through this tool one can “find and map any and every Opportunity Zone in the country, access the same platform states used to help nominate zones, identify areas of strength and opportunity in each zone based on five dimensions: housing stability, education, health and wellbeing, economic security and mobility, customize your search through a variety of filters, and access free measurement reports which provide key details on social determinants and conditions in each tract.”
Beyond the local level, there are activities taking place at the state, regional, and national levels. Convening and engagement processes are taking place all over the country. States, which according to the Council of Development Finance agencies tend to have intermediate knowledge of O-Zones and O-Funds, are doing things like coordinating with local communities, hosting educational events, assigning staff to O-Zone work, and communicating with potential O-Fund managers and investors. Some states are even considering creating their own O-Funds, which is also being considered on regional and national levels.
Stakeholders at all levels are also working to develop frameworks for successful O-Zone implementation. Common aspects of these frameworks include using data analytics and marketing strategies to attract potential investors to O-Zones that might otherwise be overlooked. Policies are also being considered to support a pipeline of investable projects, to create additional incentive structures for investors, and to provide supplemental funding for O-Zone projects.
While some investors are moving forwards and working very closely within the letter of the law, others are waiting for further guidance from the Treasury before proceeding. This latter group is waiting to learn more about rules regarding transparency and accountability. In particular, they expect that before the end of the year Sec. Mnuchin’s office will provide language that offers clarity of definitions and terms within the Investing in Opportunity Act, further explanation on how exactly to accrue key tax benefits, and more information on the length of time allowed for the deployment of capital.
Another important development to watch going forwards is a piece of legislation known as the Generating American Income and Infrastructure Now (GAIIN) Act. This bipartisan legislation, sponsored by Democratic Congressman Lacy Clay and Conservative Republicans Mike Kelley and Tedd Budd, is designed to provide federal funding to local governments “to help increase the marketability of projects otherwise unlikely to receive private investment dollars but would provide the most community benefits”. This funding would come by requiring the Department of Agriculture to sell off distressed assets, with 50% of the proceeds going to fund development in poor communities and 50% going to reduce the national debt.
Pros and Cons:
A variety of opinions on Opportunity Zones and Opportunity Funds have been circulating over the past several months. Proponents say that this program has the potential to unlock trillions of dollars in investment into areas that are in dire need of economic development, and that benefits could be felt relatively quickly with the private sector leading the way.
Critics, however, argue that this program could exacerbate the process of gentrification through either conscious or unconscious selection of areas that might not truly need O-Zone status in order to draw investment. Another common critique is that the reporting requirements which were originally included in the Investing in Opportunity Act were removed in the final version of the Tax Cuts and Jobs Act signed into law. Many would like to see reporting requirements for O-Funds reinstated in order to collect and share public information on the economic impact of O-Zones. Important data would include number of investments, impacts and outcomes, number of opportunity funds, dollar amount of assets held, and composition of assets by class. Requirements collecting this data could help to incorporate measurability, repeatability, and scalability into Opportunity Fund frameworks and strategies.
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