What changes to tax policy are likely coming under the Biden administration? If enacted, how will these changes impact the appeal of Opportunity Zone funds and the returns available to investors? Several Opportunity Zone experts provided their insights on a live panel recorded on July 27, 2021 during OZ Pitch Day, titled “Tax Policy Changes & Opportunity Zones.”
Today’s podcast episode is the audio version of that panel. Moderated by OpportunityDb founder Jimmy Atkinson, the panel featured Shay Hawkins of the Opportunity Funds Association, Kunal Merchant of CalOZ, and John Sciarretti of Novogradac.
Click the play button below to listen to the audio recording of the panel.
- A crash course in Opportunity Zone basics.
- The tax policy changes that are likely coming down the pipeline, on both the regulatory and legislative sides.
- How the Opportunity Zone program is winning support in Congress, even among some of its one-time critics.
- The likelihood of changes to the Opportunity Zone program, including transparency and reporting requirements via the IMPACT Act.
- Why an increase in capital gains tax rates may do little to diminish the appeal of Opportunity Zone incentives.
- The potential to give preferential treatment to Opportunity Zone investments in any new tax legislation.
- The role that Opportunity Zones can play in the economic recovery from COVID-19.
- How the trend towards increased state and local incentives may be a boon to projects located in Opportunity Zones.
- Why the rumored changes to 1031 exchanges may never materialize.
- What is likely to be included in a comprehensive Opportunity Zone expansion bill.
- The possible permutations of a reconciliation bill in the current Congress.
- Technical discussions of the tax advantages of different QOF structures.
Featured on This Episode
- OZ Pitch Day 2021
- John Lettieri’s Keynote Address
- Shay Hawkins | Opportunity Funds Association
- Kunal Merchant | CalOZ
- John Sciarretti | Novogradac
- Overview of the IMPACT Act
Industry Spotlight: OZ Pitch Day
The OZ Pitch Day Summer 2021 was an online event geared toward matching investors who have capital gains with Qualified Opportunity Funds that are seeking capital. The live event took place on July 27, 2021 and featured pitches from 12 Qualified Opportunity Funds, a keynote address from John Lettieri, two educational sessions, and an interactive happy hour mixer.
Learn more about OZ Pitch Day:
About the Opportunity Zones Podcast
Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.
Jimmy Atkinson: So here we are with Tax Policy and Opportunity Zones. I’m gonna bring our panelists up on stage here. John Lettieri did a pretty nice job of setting the stage early on. In his keynote address, he touched on some of the topics that we’re gonna be exploring in a lot more detail on today’s panel, which is Tax Policy and Opportunity Zones.
So I want all of the investors in the audience today, gentlemen on the panel right now, to be more comfortable with Opportunity Zones at the conclusion of this panel. So hopefully we won’t scare anybody off. But I do wanna address some concerns that people have about the impending tax policy changes that are on the horizon.
And just to introduce my panelists one more time, give them a proper introduction, Shay Hawkins, hello. He joins us today from the Opportunity Funds Association. He was formerly tax policy advisor to Senator Tim Scott. And today he continues to champion the OZ Initiative. And he’s very active on Capitol Hill. Shay, say hello, how are you.
Shay Hawkins: How’s it going, Jimmy? Thanks for having me.
Jimmy: Fantastic. Thank you Shay for joining us. We also have Kunal Merchant here with us today. He’s the president and co-founder of CalOZ, an advocacy group for Opportunity Zones in California. Kunal, how are you doing today? Good to see you.
Kunal Merchant: I’m doing well. Thanks, Jimmy. Happy to be here as well.
Jimmy: Excellent. And finally, last but not least, I’m going in alphabetical order, by the way, so John Sciarretti, partner at Novogradac, National Professional Services Organization, one of the leaders in Opportunity Zones. And John is also the coordinator of the Novogradac Opportunity Zone Working Group, also very active on Capitol Hill with their advocacy. John, how are you doing today? Good to see you.
John Sciarretti: Thanks for inviting me.
Jimmy: Good. Absolutely. Great to see you. Great to see all of you. So I wanted to go through very quickly, and hopefully this doesn’t bore anybody, and especially doesn’t for my panelists too much, but I did want to go through a very quick Opportunity Zone investing for beginners presentation, just because we do have…We’ve got a fair number of people in the room who are pretty Opportunity Zone savvy. But I think we’ve got a fair number of people joining us today who are just learning about Opportunity Zones for the first time very recently, and really just need a quick rundown. So I’m gonna try to go through this in three minutes or less. So Opportunity Zones for beginners really quickly here.
There’s three benefits for Opportunity Zone investors, and it starts when you trigger a capital gain. It can be from the sale of stocks or real estate or anything else that triggers a capital gain. It can be long term or it can be a short term capital gain. That capital gain is then subject to three benefits. One is a deferral period, you don’t have to recognize the gain until the end of 2026, which means you actually don’t owe tax on the gain until April 2027.
Number two is you get a reduction in the amount of capital gains that you’re able to recognize by 10%. Quick note, that benefit actually expires at the end of this year.
And benefit number three, and this is really the big one, this is why we’re all here today pretty much, is there’s no capital gains tax on any OZ gains after achieving a 10-year holding period. So you can dispose of your OZ investment 10 years after making the investment and it’s tax free.
We’ll run through a quick example. Let’s say you’ve got a $10 million dollar capital gain, we’ll assume a 23.8% federal capital gains tax rate. We’re going to ignore state just to keep it simple here.
Normally, you’d owe $2.38 million in tax liability the following April, which would leave you with only $7.62 million net. But instead, let’s say within 180 days of recognizing that gain, you invest that $10 million in a Qualified Opportunity Fund. So benefit number one is a deferral period. And note that you don’t get the after tax, you get the full amount. You’re able to pour in the full $10 million dollars into the QOF, the Qualified Opportunity Fund. It’s essentially a $2 million and change industry loan from Uncle Sam.
And the important thing to note, though, is that that tax liability on that gain does come home to roost eventually, and the 2026 tax rate applies then. We don’t know where tax rates are gonna go. And that’s what we’re gonna be talking about throughout the course of this panel. Tax rates could rise. Most expect that they will. But this could actually be to your benefit in the long run. When we get to benefit three you’ll see why.
Benefit number two is a reduction. Essentially you get to reduce the amount of gains that you recognize by 10%. So the $10 million gain is reduced to $9 million essentially. And again, you will have to pay the tax on that initial gain in April 2027, but it’s only $9 million of gain, so not 10.
Benefit number three, again, this is the big one. You pay zero tax on capital gains realized from the OZ investment after a 10-year holding period. Tax free growth within the Opportunity Zone investment. So let’s say your $10 million appreciates to $50 million, that’s a $40 million gain. Normally you’d owe quite a bit of money to Uncle Sam, and possibly your state as well, if they have a capital gains tax rate, or if you have Nexus in a state that does have capital gains rate. In this case, zero. Note that the gain must be recognized by the end of 2047. If tax rates go up, this benefit actually becomes much more valuable.
So I’ll skip through a couple of these slides here. But essentially, Opportunity Zones applies at the census tract level, it’s a place based policy covering over 8700 census tracts. Over 35 million people live in these tracks. And you can see that map right there shows that there are tracks all over the country to invest in. So that’s a very brief overview, OZ 101. I hope I did okay, gentlemen. But let me turn it over to you now. You guys are the real experts here in the space.
I want to get a sense from you guys, ask the first question of the day here. Since we’re focusing on tax policy changes, I wanna ask each of you, and I’ll just go through in order here. What are the tax policy changes that are likely heading down the pipeline? And are they regulatory changes or are they legislative changes? Shay, I’ll turn it over to you first to get your thoughts, please.
Shay: Well, thanks, Jimmy, for that overview, first of all. It was pretty thorough. I thought we were gonna have to spend 20 minutes with Kunal, John, and I correcting that. But that was pretty solid.
So, you know, I’m obviously open to any adjustments or additions or corrections from John and Kunal. But in a broad sense, in terms of potential tax changes, of course, the Opportunity Zone policy is structured around capital gains. And as you mentioned, capital gains are, you know, kind of in the news now. The Biden infrastructure/job creation plan calls for a number of new tax increases to help offset the cost. And one of those is essentially a doubling of the statutory capital gains tax rate.
And so, you know, the overall view on that, you know, a capital gains tax increase wouldn’t be a part of a theoretical bipartisan infrastructure plan. And so that’s out there. But if they can’t get bipartisan cooperation and they can’t get any Republicans on board, then the Democrats can move forward with a process called reconciliation, which is basically a complex parliamentary and budget process that allows major legislation to pass this in the U.S. Senate without, you know, with just 51 votes, which the Democrats have.
And so if they use this process, then the bill will be a lot more aggressive in a lot more ways. And one of those ways, you know, it will make sense for the Democrats if they do reconciliation to raise the capital gains rate.
And when I say it makes sense, I mean, there’s a lot of revenue to be drawn in terms of tax revenue from raising capital gains rate, especially if they raised it, especially if they double it.
But then also, you know, the constituency, if you will, that pays capital gains, you know, particularly, you know, people who are perceived as wealthy, are kind of easy targets in this environment. And so it’s not a guarantee that you’ll see a reconciliation bill, but if you see a reconciliation bill for infrastructure, then you will very, very, very likely see that capital gains tax increase.
And so, fortunately, you haven’t heard a lot of rhetoric around sort of closing loopholes in connection with…You know, I almost don’t wanna say it out loud here because I don’t want to get any of the staffers on Capitol Hill any ideas. But you don’t hear a lot of discussion of saying, “Okay, we’re gonna raise capital gains, but then we have to do the following, you know, three to five things to make sure that there’s nowhere for those capital gains to go as it were.”
And so, you know, on the surface, you know, we would see a capital gains tax increase and that could make Opportunity Zones an even more attractive location for realized capital gains.
You know, if you do see, you know, some type of adjustment, you know, to sort of make sure that those capital gains are kept in the Treasury, if you will, the tax associated with those, then obviously that could be, you know, that could be bad, that could lead to some unhelpful changes. But I haven’t seen anything on the horizon.
In the past year and just so far in this year, 2021, since the new administration has taken over, and since the majority switched over, I’ve testified in front of Congress four times. And so twice in front of the Energy and Commerce Committee, once in terms of…I’m sorry, once in front of the Energy and Commerce Committee, twice in front of the House Oversight and Reform Committee. And once in front of the Tax Writing Senate Finance Committee.
My point is this, is that in each one of those testimonies, about a third of my testimony focused on Opportunity Zones. And the questioning that I received both from Democrats and Republicans also focused on Opportunity Zones.
And so we didn’t see anything particularly hostile during that questioning, you know, when they had one of us, you know, an Opportunity Zone expert in front of them. And you particularly didn’t see anything negative that was associated with this current tax bill.
And so that’s, you know, that’s encouraging because, you know, some of the chief enemies… On the Oversight Reform Committee, the two members of Congress who have introduced Opportunity Zone repeal legislation, Representative Ocasio Cortez and Representative Rashida Tlaib, were both on the committee, both mentioned Opportunity Zones but neither was particularly hostile.
In fact, Rashida Tlaib bemoaned the bipartisan support that Opportunity Zones had. She said, “I’m done with Opportunity Zones, both Democrats and Republicans, you know, are constantly promoting this.” And so that was actually positive.
And then she also mentioned that billionaires have hijacked our Opportunity Zones, which sounds negative, but if you really think about it, you know, she’s acknowledging that Opportunity Zones are positive. And she’s, you know, in her mind, a certain segment of the investor population have somehow, you know, perverted them, if you will.
So, you know, in Capitol Hill speak that’s actually not very bad at all. It means good things for us and for the people on this call. And so, beyond that, you know, the primary theme that I’ve heard regarding Opportunity Zones from the administration, from HUD, from Republicans on Capitol Hill, is the need for, you know, reasonable transparency reporting requirements. And the good thing is we have that in the form of the IMPACT Act. It’s a bill that’s, you know, a solid industry bedded bill that Senator Sinema and Senator Scott introduced in December 2019.
So legislation like that and a comprehensive bill are gonna be important to avoid regulatory changes from Treasury. You know, the worst thing that could happen is you get a bad Opportunity Zone headline and Secretary Yellen, Treasury Secretary Yellen feels the need to “do something” about transparency, or the performance of Opportunity Zones.
With the IMPACT Act out there as a placeholder, when she comes under that pressure, and if we make that placeholder even more comprehensive, then she can point to that and say Congress should pass this comprehensive Opportunity Zone bill as opposed to feeling that she needs to do something unproductive from a regulatory standpoint.
Jimmy: Good. Well, hey, Shay, thank you for that perspective and that peek behind the curtain that is Capitol Hill. Kunal, I wanna turn to you now. I’ll pose the question again. What are the tax policy changes that are likely hidden down the pipeline in your mind? And do you think they’re gonna be regulatory or legislative?
Kunal: Yeah. So I mean, obviously, Shay is incredibly knowledgeable. I mean, the short answer is both. Right. So on the legislative side, there’s a discussion about capital gains independent of Opportunity Zones that’s going on right now, either as a pay for the infrastructure or just as a revenue generally.
One thing I think we should just get out there, which I think Shay kind of alluded to is just there was concern perhaps at the beginning of the administration or the change in the Congress, you know, would Opportunity Zones survive at all? And the answer is yes.
So for investors who have to make these long term bets with their earnings, very, very unlikely that the program would somehow get abolished. There’s going to be legislation always introduced on either side of the aisle. That’s probably something that’s more symbolic than substantive. I wouldn’t put any stock in any of these bills that are claiming to end zones or end the program. It does have bipartisan support, there’s just not a path for the legislature to end the incentive.
You know, Senator Scott and Senator Sinema with the IMPACT Act is a critical piece of this puzzle, this reporting piece, that is missing. That was missing in the original legislation because of mainly a technicality of how reconciliation works. But was never remedied after that by either Republicans or Democrats. And it leaves the program vulnerable to criticism in the sense that we don’t fully understand what the money flow is, where it’s going.
You know, the reporting requirements are relatively lean compared to other programs. In some ways that’s a good thing, because it’s sort of a less of an inhibitor for investors trying to do this or project sponsors trying to get the projects forward. But it does leave it open to criticism that this is some sort of program that doesn’t account for the dollars that are being, you know, alleged to be going to IMPACT. So hopefully, Senator Scott’s bill makes its way through the Congress, as Shay would obviously know better than me.
Beyond that, there may be other, you know, tax policy changes generally with, you know, tax rates, marginal tax rates, that sort of thing. But Shay alluded to another important mechanism, which is the administrative regulatory mechanism.
So Congress is one lever to create change. The other is just the Executive Office of the President that, you know, what the Treasury can do, what the IRS can do, what the agency even HUD can do. There’s administrative regulatory changes they can make to, you know, change the forms that people fill out when they’re doing their tax returns, you know, on an annual basis, or just other things related to Opportunity Zones.
I suspect that over the course of the next few months, maybe year and a half, we’ll see some adjustments to those coming out of Treasury, coming out of the IRS, similar to how we had in the Trump administration.
Initially, however, I have not gotten the sense that in terms of the rank order preferences of the Biden administration right now, Opportunity Zones are super high relative to COVID, relative to infrastructure, relative to other priorities. So it seems like their hands are full with other topics at the moment. So, you know, for the investors who are trying to make bets on, you know, whether to do this or not, I would, you know…It’s easy to say it’s not my money, it’s your money, but I think that the system as set up right now is probably gonna stay intact to the extent that changes will be around the edges.
I think the big one is the capital gains question, but I know at least, you know, one analysis by UBS about a month ago concluded that even if cap gains go up to 43.4%, which would be a pretty significant increase from the status quo, it would still make more sense to put your money into the OZ program, and you’ll get a higher net present value of returns compared to paying those capital gains taxes today.
So given that that really high capital gains rate is unlikely, and this analysis is saying it’s still gonna be worth paying later and getting the deferral, we feel like the regulatory changes shouldn’t be something that inhibits or deters anybody here from moving ahead with an Opportunity Zone project.
Jimmy: Excellent. Thank you for your perspective, Kunal. And, John, I want to hear from you now. These two are hogging up all the airtime here. Let’s get to John here. I wanna hear John again. For those of you just joining, he’s a partner at Novogradac and he’s also the coordinator of the Novogradac Opportunity Zones Working Group. John, what’s your take? What tax policy changes do you see hidden down the pipeline? And I’ll also ask you a follow-up question, what impact do you think these tax policy changes may have on Opportunity Zone investors?
John: Well, specifically, you know, the Biden administration released their Green Book, which is their revenue proposal. And some of the titles in that Green Book that may affect Opportunity Zones, which, in general, higher tax rates, corporate rate. The proposal was to go to 28%, which we haven’t had to date much institutional investment in the program. And it seems to be picking up. At least in my world, I see more institutional investors. But, you know, obviously a higher tax rate would give them more incentive to invest in Opportunity Zones.
And then what Shay and Kunal mentioned about the individual rate, you know, the proposal was to go to 39.6, which, in effect would, you know, make new Opportunity Zone investments at that rate, a higher incentive, deferral, and in the back-end, gain forgiveness. Of course, investors that have already invested at 28%, which you alluded to, Jimmy, you know, if that rate should change and survive through ’26, you would have, you know, a higher tax rate on that realization of the deferral. But assuming it stayed in place through the 10 years, you know, based on our math it’s still a beneficial investment, you know, to invest or to keep your investment.
We looked at some opportunities to sort of realize an inclusion event at a lower rate before any tax change would take effect. And the only opportunity in the tax code now or in the regulations is that if you were able to get a distribution of your investment, and you didn’t have basis when you got that distribution, which is pretty…typically distributions come in the form of debt finance distributions. And typically the investors have basis in that debt and so they don’t realize an inclusion event.
But the regulations say today that if you have an inclusion event as a result of a debt financed distribution, that you still keep your 10-year-old benefit. So, you know, there are ways you can manage that through some sort of related party debt, which I won’t get into now, but we had actually asked…It’s probably a statutory change, but we did ask for a regulatory change to allow this sort of election to realize your gain at that lower rate before any tax changes. So definitely the tax changes would affect, you know, current investors and future investors more favorably.
Another provision in that revenue proposal was to tax capital gains in the event of a gift or death. So currently the law is that basis transfers on a gift, an investment would be…the basis would be the fair market value at that and decedents escape any taxation on that fair value over basis.
In the proposal, there’s a provision which proposes to tax that unrealized capital gain at death or gift. So obviously, that would affect Opportunity Zones in that death is not an inclusion event today. So if you hold an Opportunity Zone investment and a decedent would pass that benefit onto its heirs without any tax or inclusion at death, and the holding period isn’t taxed.
And so if someone were to pass away in the sixth year of investment, then the beneficiary would only have four years and then they could actually realize the 10-year-old benefit. Of course, this provision to tax capital gains would take that away. And there probably wouldn’t be the ability to defer those gains again into an Opportunity Zone investment because in order to defer capital gains into an Opportunity Zone investment you have to have a sale or an exchange, which by definition that is not a sale or an exchange. And it has to be an unrelated party. And typically, you know, beneficiaries are related parties. So we’re not sure how that would play out.
But there is a provision in that proposal that says that 1202 or small business stock benefits are not erased or are not taxed on the decedent.
And so our Opportunity Zone workgroup is watching it closely. We wanna make sure we get out in front of this and hope to have an exclusion for Opportunity Zones as well, along with the 1202. It make sense that the decedents that invested thought that they, you know, could realize the benefit. Even though they passed away, that they, you know, that they get to keep that benefit.
And then the last issue and the last title in that proposal was the elimination of what kind of exchange. I think it’s over half a million dollars. So that’s the only deferral that you can…any deferral over half a million dollars would no longer be available. So that limit on the kind of exchange, obviously, would make Opportunity Zones the only game in town for deferral around real estate. Obviously, you have the small business stock deferral but…Obviously, that proposal, if it were to go through would make Opportunity Zones more popular.
Again, they’re all proposals. Shay sort of laid out the landscape that I think it’s a tough challenge to raise taxes. I think the capital gains tax, I think it’s been over 50 years where it’s at a preferential rate. And there’s been proposals over those years to make it the same as ordinary rate. And so, you know, it’s, like I said, it’s a tough row to hoe for Congress to increase those capital gains rates.
Jimmy: Yeah, but it is what a lot of people are expecting to come down the pipeline at some point, right?
John: Yeah, I think it’s probably more likely to go up but not to 39.6%, you know, where you would still have a preference for capital gains. You know, the economy’s recovering from COVID. That just makes it a tougher challenge for the administration to raise those rates.
Jimmy: Yeah. Fair enough. Well, in any case, though, I do think we are expecting them to go up at least a little bit, maybe not as high as Shay alluded to, maybe not to ordinary rates. And what I hear from investors a lot of the time, and I’m sure John and Shay and Kunal you hear this as well is, “Hey, why should I invest in a Qualified Opportunity Fund? I can just lock in my 23.8% rate right now and be done with it. Whereas, otherwise, I’ve got to defer that gain recognition and I’m gonna be paying who knows what at the 2026 rates.” I think it spooks off some investors.
So I just want to drive the point home one more time that, you know, John, as you alluded to, the rates going up actually still has a pretty substantial economic benefit especially when you take into account that third benefit that I ran through in my OZ 101 intro, it makes that exclusion event on the back-end, those tax-free profits from Opportunity Zone investing much more powerful I believe. Any other thoughts from you guys on that?
John: No, I agree with you. I mean, I think we analyzed that if rates were to go up to 39.6%, which actually ends up being 43% because of the investment tax that you pay. That, you know, depending on whether they stay there in ’26, which could be another administration and another tax policy, and depending on what your appreciation is. So I think we looked at it the way you sort of double your investment, you’re still ahead.
Jimmy: Kunal, thoughts from you?
Kunal: Yeah. I mean, I, you know, I was persuaded by that. There was this UBS report that came out in early June that basically made some assumptions that if there was, you know, a million dollar gain with a 10% capital gain exclusion, and that the breakeven was 43%. That is 7% discount rate and a 7% CAGR. So, you know, it’s a math problem, right? Like, you’re better off taking the hit now and then having a certainty, or do you take the deferral going forward? You know, a lot of it is project-specific, like John said. If you believe in your project, you believe in the appreciation, I don’t think rates will get up to 43%. You know, personally, I do think it’s still okay to move ahead on OZ project, but, you know, every project is different. There may be some unique factors that may motivate some folks to act differently, but I think on the whole, it’s safe to proceed.
Jimmy: Good. Shay, any thoughts from you?
Shay: Oh. Well, first of all, I’m allowed to take a good portion of John’s time in each cycle because I’m part of the Opportunity Zone Working Group for Novogradac. So as a working group member, I could always take a little Novogradac time, you know.
John: We appreciate that.
But no, I think, you know, what really stood out is…And one thing that I failed to mention was the gift and tax potential impact that John noted, you know. Because then you’re in a situation where there’s gonna be a significant portion of the investor class that’s just literally…that has a forced capital gain, you know. And has to kind of deal with it.
And so, you know, I think that could be, you know, a positive driver for, you know, for these investments overall. And then, you know, I tend to agree. I mean, I don’t think, you know, a capital gains rate going to 30% or, you know, or 28%, or something like that, it’s not, you know… It’s not gonna, you know, cause $24 billion in, you know, new investment to, you know, to drop to six over the next three years.
And it could be that the combination of changes that are in the ultimate, you know, in the final reconciliation bill, you know, are neutral to positive for Opportunity Zones. But, you know, we just have to, you know, as John said, just monitor it day-to-day and just make sure that…You know, in a perfect world, we would get Opportunity Zones excluded from, you know, the potentially damaging changes.
And then benefit for, you know, from some of the other potential changes. And there’s good precedent, if you will, you know, for getting Opportunity Zones treated a little differently, and that we have had bipartisan Opportunity Zone oriented legislation on tax with this treatment of Puerto Rico and their designations.
And then also, you know, we have seen some positive regulatory changes for Opportunity Zones related to COVID. Now, granted, those happened under a different administration. But, you know, the nature of those regulatory changes were not challenged by “the other side” during that time.
So, you know, it seems like there’s a recognition that Opportunity Zones are key to us recovering from the pandemic, and we wanna treat them in a way that allows it to continue to be an incentive.
Kunal: And Jimmy, I know we’re almost at time, but Shay kind of hit a really important point, which I think is good for folks out there to look at, which is one area that seems to be less contentious is the idea of aligning policies with the zones. So irrespective of the conformity, the tax benefit, both sides seem to be comfortable with the methodology of saying, “Hey, this geography, which is now an Opportunity Zone tract, is worthy of increased attention.” That seems to be bipartisan.
So as you’re looking at your projects, be on the lookout for changes to federal and state policies that are not trying to align more tax incentives, more subsidies, more public policies generally to incentivize and benefit projects that are in designated Opportunity Zones, irrespective of the tax benefit. So there may be other ways to improve your project with state and tax and sometimes even local policy. That’s a trend we have been seeing. So just beyond the capital gains piece, be on the lookout for that as well.
Jimmy: Yeah. Yeah, a really good point. I did wanna…I think we’re actually at time right now and I wanna take a break. But I did wanna get to a few questions, so let’s go for a few more minutes if you gentlemen have time. Our next fund pitch, excuse me, will be starting at 11:45 a.m. Eastern Time in about nine minutes.
David asks, “Can you talk about proposals for raising capital gains and eliminating the 1031 exchange?” I don’t know if we’ve talked about 1031 yet, but what are your thoughts on whether or not that may be on the chopping block? This is gonna be rapid fire, so whoever wants it.
John: I mean, the only indication we have is the revenue proposal, right? Which does indicate that there would be limits to the 1031 of only half a million dollars. What was the other thing other than…?
Jimmy: Oh, he wanted to discuss proposals for raising the capital gains rate. I think we’ve discussed that.
John: Yeah, that’s the Green Book proposal.
Kunal: Yeah, Shay, I don’t know about you, but I don’t think there’s enough votes to get rid of 1031 in Congress. Is that right?
Jimmy: Yeah. Shay, yes or no, 1031s on the chopping board?
Shay: Very unlikely that 1031s are eliminated. If they did, it would only help Opportunity Zones. But very unlikely.
Jimmy: Agreed. Dane asks, “Would the end of year 2021 capital gains providing step up of 10% possibly be expanded into 2022 due to the delays and events of the past 15 plus months?” So again, that 10% basis step up or 10% capital gain recognition reduction that’s expiring at the end of this year. Gentlemen, any chance that that could get extended into 2022 and beyond? Shay, you go first, I know you’ve got a good one for this.
Shay: No. That would be a part of a comprehensive Opportunity Zone expansion bill. So you would lay a foundation of, you know…you would lay a foundation around transparency reporting because there’s bipartisan support for that. And the Biden administration has indicated that that’s a priority. So that’s the foundation and then you overlay, you know, things like, you know, extending the 10% step up in basis, extending the policy overall, allowing governors to designate additional zones, those kinds of things.
And so a comprehensive bill is a possibility. And it’s important to have something as a placeholder because even if you don’t get it passed this year, it’s out there for future vehicles, and also it takes the pressure off of the potentially negative regulatory steps that Treasury or IRS might take.
John: Yeah, there’s a proposed bill out there, right? That extend to ’28. Because that’s how you’d end up getting a step up because you’d end up pulling your investment. But required five or seven years.
Jimmy: Kunal, any thoughts there?
Kunal: No, I think they hit it.
Jimmy: Excellent. We got a couple more questions here we wanna get to. I think we’re gonna blow right through the break. But that’s okay. That break’s really just for me. I don’t need it. I’m good. So let’s see here. We’ve got one. We’ve got another one from Dane, actually. He has a technical question. Isn’t the senate only allowed to use the reconciliation process for two bills each year? And with each of these, there needs to be a budget resolution. If that’s the case, what is the rank order of capital gains tax increases being one of the two bills? And also if the capital gains tax increase is put into place, they should get people off the sidelines and realize capital gains now and will need to redeploy into other investments, what do the panelists see as an alternative for deploying capital gains on any assets? Because eventually people do need to realize those capital gains.
Shay: Right, So in short, there’s another reconciliation that it is possible this year. And, you know, tax policy, everything that they wanna roll into it, from the international changes to an international tax policy, everything we’re talking about, the individual side. A potential increase in the corporate rate would all be rolled into one reconciliation bill because it’s like herding cats, you got to get all of the majority on one page at one time. So you wouldn’t try to split that up, you would do it in this next bill.
Jimmy: Thoughts from Kunal or John on that question, or did Shay hit it?
John: I think he hit it. I think even reconciliation, there’s the mansion wildcard, right? But, you know, so it’s not a given.
Jimmy: I’ve got a few stump the accountant type questions here in the chat. I may address you with these, John, so watch out. The previous speaker from Urban Catalyst, Erik Hayden, mentioned the…briefly he mentioned a fourth tax benefit, which was the elimination of depreciation recapture. This question asks…Let’s see. Basically, depreciation from investment held 10 years becomes permanent and can be used to offset ordinary income. Would this influence your decision to choose a QOF that reports on a K-1 versus a 1099?
John: Yeah, I guess it would. I mean, that’s a huge benefit in that, you know, under normal…On a general tax law, any depreciation you take is recaptured at a higher rate. For individuals it’s 25 versus 20 for capital gains. So what the Opportunity Zone regulations gave us is that you step up through that as well as the additional appreciation. So it’s a huge benefit investing in real estate through Opportunity Zones.
Jimmy: And then I’ll hit you with one more, John, also. This one comes from Robert in our live audience. If a married spouse sold stock owned personally, does the Opportunity Zone investment need to be with that spouse or can it be a joint purchase? And they file taxes jointly, he says.
John: Yeah, if you file jointly then, you know, it will be that tax payer, the joint tax payer.
Jimmy: Good. Good. Let’s see if we have any other questions here. I think we might wrap it there actually. Give myself a couple minute break before the next panel. So I wanna thank everybody again for joining me. John, Kunal, and Shay, thank you for all of your insights today. We’ll stop with stump the CPA there. And thank you, everybody, for joining. We’ll get resuming with the programming in just a couple of minutes here. Nest Opportunity Fund is up next. Thanks, guys.
John: Thanks, Jimmy.
Kunal: Thank you.
Shay: Thanks, Jimmy.