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On June 14, 2018, the federal government officially released the list of Qualified Opportunity Zone designations across the country. There are 628 of these zones that have been designated in Texas, with 40 zones here in the CAPCOG region.
So, what is an Opportunity Zone?
Great question - The federal tax bill (Officially: The Tax Cuts and Jobs Act) that was signed at the end of 2017 created an Opportunity Zone program. It’s a new federal tax program. You are forgiven for not having made it all the way to page 130 of the legislation, where “Subchapter Z – Opportunity Zones” begins.
Well, that’s an excellent way of answering my question without really giving me helpful information. Why are you blogging about a federal tax program?
Hang on. We’re getting there. The intended purpose of the program is to spur investment into lower-income communities, via a new tax break on capital gains that are reinvested into Qualified Opportunity Funds. Each Opportunity Fund invests its assets into eligible projects in designated Opportunity Zones, and the range of eligible projects is wide, including housing, commercial developments, TODs, infrastructure, brownfield development, and even stocks in new businesses. The program is intended to be flexible and responsive to local needs, with minimal bureaucratic red-tape and an incentive structure that offers investors greater rewards for leaving their funds in place for longer amounts of time. The capital gains tax liability benefits are scheduled like this:
Table 1: Benefits Schedule for Opportunity Zone Investment [i]
OK, so that explains why an investor might be interested. Do you have a diagram or something of how this whole program would work?
Depends. How do you feel about ClipArt?
Figure 1: Opportunity Zone Program Diagram
OK. So investors invest in Qualified Opportunity Funds, which turn around and invest in projects in Opportunity Zones. What counts as an Opportunity Zone? Where are these places?
You are asking some really great questions. So, Opportunity Zone designations are made at the census tract level, and the criteria for eligibility are[ii]:
Figure 2: Designated Opportunity Zone Tracts – Capital Area
So, if we know what Opportunity Zones are, and we know where they are, what should we make of all this?
This is the part where I tell you that these are still early days for the program, and the Treasury Department is expected to release more specific guidelines for how the program will work later this year. That said, there are a couple of big picture policy questions that are worth thinking about.
What kinds of investments should we expect Opportunity Funds to make?
This remains to be seen. This can be a source of capital for local businesses, as Qualified Opportunity Funds can invest in equity interests in businesses in Opportunity Zones. The current guidance makes businesses that operate primarily within the Opportunity Zone and were created after 2017 the easiest investment targets. There are also a series of categorical exclusions for Opportunity Zone business investments that include golf courses, country clubs, massage parlors, bars, etc.
In addition to investing in businesses, Qualified Opportunity Funds can invest in real property, meaning they can acquire real estate, develop housing or commercial property, or even fund public assets. It is easy to see the potential for Qualified Opportunity Funds to provide the capital needed to help build affordable housing and commercial spaces. Moreover, Opportunity Funds can also pair with other funding sources (e.g., Low-Income Housing Tax Credits, New Market Tax Credits, etc.) to leverage existing financing tools and make them go further.
If the goal of this program is to spark investment in low-income neighborhoods, how do communities work to ensure that these investments minimize negative consequences, like unaffordability and displacement?
This was one of the key questions about the program during the period where Opportunity Zone designations were being made. Would governors select tracts that were already experiencing rapid redevelopment and displacement? In the CAPCOG region, there appears to be a mix of designations, some that are in rapidly developing or redeveloping areas, and some areas that do seem to really lack for investment overall. While it’s tempting to suggest that this pattern follows a rural-versus-urban divide, many of the rural designations are also in rapidly developing areas. Kingsland in Llano County, for example, is the fastest growing part of that largely rural county.
More broadly, however, the question of impacts from the program probably comes down to the nature of the projects that are developed with Opportunity Fund investment. How can communities work to ensure that these projects are aligned with the community’s priorities for the area? Jurisdictions are still doing a lot of work to figure out an answer to this question.
It's too early to say at this point, but it could! The potential is massive. U.S. households and corporations are currently sitting on $6 trillion in unrealized capital gains. The incentive to defer or reduce the tax liability from those gains means that there could be enormous flows of assets into these Qualified Opportunity Funds.
At the same time, Qualified Opportunity Funds still need to identify productive investments in Opportunity Zones. And for a program that sets out with the expressed mission of addressing poverty to be successful, the question of who benefits from investments in Opportunity Zones is of critical importance as well. If a flood of investment into a community dramatically improves quality of life there without protecting and lifting up the existing residents, an Opportunity Zone designation could simply push lower-income residents out of their neighborhood. Policymakers and planners will need to be proactive to ensure the Opportunity Zone program truly alleviates poverty, rather than merely displacing it.
Sources: We’ve relied heavily on a number of online sources for research on this topic. Those sources are outlined in the endnotes that follow.[iii]
[ii] The definition of a Low-Income Community can be found in 45D(e) here: https://www.gpo.gov/fdsys/pkg/USCODE-2010-title26/pdf/USCODE-2010-title26-subtitleA-chap1-subchapA-partIV-subpartD-sec45D.pdf
[iii] Helpful Sources:
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