(November 2018) The passage of the December 2017 tax law sparked intense interest in the new Opportunity Zones initiative from investors and community organizations. Opportunity Zones were designed to incentivize individuals and corporations with capital gains to invest them in designated census tracts by allowing them to defer paying taxes on those gains.
Since that time, our NCST team has received a number of questions around Opportunity Zones from our partners, including the following: Are Opportunity Zones good for the communities we serve? How does our work on blight prevention and single family home rehabilitation fit into the initiative? And how can our Community Buyers tap into any benefits that this creates?
The recently released initial set of proposed regulations provides a good opportunity for us to share some of our current thoughts on these questions.
First, how does the Opportunity Zone initiative work?
There are many other good sources for Opportunity Zones 101, but the basic process flow is that investors who have capital gains from selling an asset (we’ll call it Asset 1) can direct some or all of that gain to a Qualified Opportunity Fund, which then invests in one or more Qualified Opportunity Zone Properties (Asset 2) located in the Qualified Opportunity Zones designated in June 2018. Investors benefit by being able to defer paying their capital gains taxes on Asset 1, being able to pay less in Asset 1 capital gains taxes if they hold Asset 2 for 5-10 years, and paying no taxes on Asset 2 appreciation if it is held for at least 10 years.
Are Opportunity Zones good for the communities we serve?
It’s too early to tell. After the law was passed, states rushed to nominate census tracts for Opportunity Zone designation, and the resulting final list of designated zones included areas with lower incomes and higher poverty rates than non-designated areas but also have roughly the same level of prior investment as non-designated areas.
There is also growing concern that the cost of lost tax revenue could outweigh benefits to distressed communities; that the zones are in areas already gentrifying or likely to gentrify; that there are inadequate certification guardrails; and that an annual reporting requirements provision referenced in previous versions of the bill and in the Committee Conference Report has been omitted.
Additionally, the broad statutory language raised numerous implementation questions and left ample room for regulations to fill in the details of the initiative, so regulatory efforts will significantly affect the impact of Opportunity Zones. The bottom line: merely designating an area as an Opportunity Zone will not automatically produce an increase in investment in that area. We will likely not know what benefits accrue to communities until we see outcomes data.
How does our work on blight prevention and single family home rehab align with the goals of the initiative?
It is not clear that Opportunity Zones will encourage investment in the kind of single family home rehabilitation work that most of our Community Buyers do. The main reason for this skepticism is that the law specifies that investors receive the maximum amount of tax benefit if they hold an Opportunity Fund asset for ten years, which does not match up with the much shorter timeframe of acquiring and rehabbing for resale. That said, the holding requirement could align with the work of our buyers who rehab homes for long-term, affordable rental.
Additionally, one previous concern about the statute’s definition of “substantial improvement” has now been allayed. Language in the statute states that in order to be considered “substantially improved,” a qualified property’s basis after 30 months must be greater than “an amount equal to the adjusted basis of such property at the beginning of such 30-month period in the hands of the qualified opportunity fund.” It was not clear from the plain language of the statute whether the term “basis” in this clause referred to the value of the land plus the value of the building.
The first set of proposed IRS regulations with its accompanying revenue ruling clarifies that “a substantial improvement to the building is measured by the [Qualified Opportunity Fund’s] additions to the adjusted basis of the building [and not the land].” The notice specifies that “[e]xcluding the basis of land from the amount that needs to be doubled…for a building to be substantially improved facilitates repurposing vacant buildings in qualified opportunity zones.” This interpretation is favorable toward our Community Buyers’ single family acquisition and rehab work, as the average purchase amount across our current markets is $71,832 and the average cost of rehab is $47,523.
How can our buyers tap into capital created by Opportunity Zones?
Until further regulations are issued, we expect that there will continue to be some uncertainty about the parameters of the Opportunity Zones initiative. In the meantime, you can stay informed and involved through the following options:
- By 2019, NCST will have an overlay in our REOMatch system that will allow our Community Buyers to view the Opportunity Zones in their own service areas. Until then, any buyer who would like our help mapping their local Opportunity Zones should contact us individually.
- Check for updates from reputable sources. There are several websites that provide information on the latest regulatory updates, Fund creations, mapping tools, and more.
- IRS Newsroom for Opportunity Zones news releases: https://www.irs.gov/newsroom
- CDFI Fund for Opportunity Zone designation information: https://www.cdfifund.gov/pages/opportunity-zones.aspx
- Enterprise: https://www.enterprisecommunity.org/financing-and-development/opportunity-zones-program
- Economic Innovation Group: https://eig.org/opportunityzones
- LISC: http://www.lisc.org/our-initiatives/opportunity-zones/
- National Council of State Housing Agencies Opportunity Fund Directory: https://www.ncsha.org/resource/opportunity-zone-fund-directory/
- Participate in the rulemaking process by submitting a formal comment on the initial proposed rule via federalregister.gov by December 28, 2018. The IRS is asking for feedback on all aspects of the “substantial improvement” definition. You can also use the comment section to propose topics for the public hearing scheduled for January 10, 2019, in Washington, D.C.
Theodora “Theo” Chang serves as Senior Policy Associate for NCST.