A new provision, called the Investing in Opportunity Act, was passed as part of the 2017 tax reform. It is designed to spur new private investment in low-income communities by providing tax incentives to investors.
The new provision allows investors (private companies, public organizations, nonprofits, and even individuals) to divert capital gains from stocks and real estate into new “Opportunity Funds.” These capital gains are rolled over tax-free and remain untaxed as long as they are in the Opportunity Fund. The money placed in an Opportunity Fund must be invested into an “Opportunity Zone.”
What exactly is an Opportunity Zone?
Opportunity Zones are low-income census tracts with at least 20% of households in poverty and a median household income that’s less than 80% that of the surrounding area. State governors were asked to nominate one quarter of the eligible tracts in their state, selecting the neighborhoods they believed needed investment most, pending approval by the US Treasury Department. In June of this year, the Treasury Department certified 8,700 tracts across all 50 states (including D.C. and the four U.S. territories), and these tracts will officially be designated as Opportunity Zones for the next ten years. Click here to see a map of all of the certified Opportunity Zones (To view, deselect 2011-2015 LIC Census Tract from the layers, then zoom in to your desired location).
What kinds of investments are possible in Opportunity Zones?
Opportunity Funds can be used for the following:
- Financing a new business or startup
- Investing in an existing business as a partner
- Financing new commercial construction
- Financing substantial rehabilitation of existing commercial real estate – improvements must equal or exceed the original purchase price of the property
Investors can extract their money from the fund any time, but there are benefits to staying invested for longer. If an investor withdraws their money from the Opportunity Fund before five years, they will have to pay the normal capital gains tax rate on both their initial investment and any subsequent earnings (however, even if paying the full tax rate, investors can benefit from the tax deferral if they want to offset future loses).
If investors leave their money in the Opportunity Fund for more than five years, the benefits are substantial:
- If investors cash out of the fund within 5-7 years, they only pay capital gains on 90% of the original investment, but they pay full capital gains on any earned income
- If investors cash out of the fund within 7-10 years, they only pay capital gains on 85% of the original investment, but they pay full capital gains on any earned income
- If investors cash out of the fund after 10 years, they only pay capital gains on 85% of the original investment, but they pay NO capital gains tax on earned income
What are the implications?
Imagine if Facebook had started in a garage in an Opportunity Zone. If investors bought Facebook stock with money from an Opportunity Fund, all of their earnings would have been untaxed.
Imagine if the New York City Highline were in an opportunity zone. If investors used money from an Opportunity Fund to develop this property into what it is today, their earnings on this wildly successful revitalization project would have been untaxed.
Many investors are looking for these types of windfalls. But, just as many investors will be looking for smaller, safer investments in new and existing businesses and real estate investment projects. Excitingly, nonprofits, governments, and individuals can set up their own funds and these may go towards public improvement projects and local services that may have been hard to support in the past.
What does this mean for downtowns?
Now is the time to take stock of your downtown: What services and offerings does your downtown need to provide that it’s not providing currently? What properties and lots are in need of rehabilitation or development? How much work will have to be done? What’s an estimate of costs and timelines? What assets does your downtown already have that makes your neighborhood a great area to invest? What kinds of people live in your downtown (What do they like to do? How much do they make and spend?). What are the local traffic patterns? How do people get downtown (walk, bike, public transit, car)? Are there any local businesses primed to expand and in need of additional capital? Are there local entrepreneurs looking to start their first venture? Investors will be looking for opportunities and you will want to be ready with this information and more.
For low-income residents and stakeholders, it will also be important to understand the types of investments that grow local wealth and minimize displacement. Find partners to help you plan and advocate for this type of investment.
What does this mean for investors?
There are several rules in place (finalized rules will be handed down by the IRS at end of 2018) that mandate investors move swiftly:
- Capital gains must be invested into an Opportunity Fund within 180 days after the gain is realized
- 90% of the money in the Opportunity Fund must be invested in Opportunity Zone projects
- Investors must make swift and significant upgrades (the Treasury Department is still deciding on the exact time frame)
What are the implications?
Once capital gains are realized, investors will have to move fast. However, new investments in low-income or disinvested markets may be riskier. Investors will benefit from partnerships with stakeholders or consultants that understand the characteristics of the local neighborhood. These partners can help with research and on-the-ground assessments to assure due-diligence within a swift time frame.
Here at Larisa Ortiz Associates, we have already begun to work with downtown commercial districts in Opportunity Zones to help get them investment-ready. As part of our SMAR2T Approach, we carry out comprehensive market analyses that account for challenges and opportunities in the physical environment, business environment, local administrative/ regulatory framework, and demographics. By doing so, we are able to create actionable and market-based blueprints for investment that can now guide the use of Opportunity Funds.
There are trillions of dollars of unrealized capital gains in U.S. stocks and mutual funds alone (and trillions more in real estate and other assets). Opportunity Funds are a new investment vehicle that will likely redistribute substantial amounts of money across the country. If you are located in an Opportunity Zone, now is the time to carefully understand your local market, your communities’ challenges and opportunities, and get investment-ready!