This is Chapter 2 of The Ultimate Guide to Opportunity Zone Investing
Updated October 29, 2020
It will be the biggest economic development program in U.S. history.
So says Steve Glickman, co-founder and former CEO of the Economic Innovation Group, and one of the chief architects of the Investing in Opportunity Act.
Here’s why Glickman is so optimistic: Among U.S. investors and corporations, approximately $6.1 trillion in unrealized capital gains is sitting on the sidelines, as of the end of 2017.
Additionally, hundreds of billions of dollars of capital gains are realized every year. In 2014 alone, Americans claimed $716 billion in realized capital gains on their tax returns. The stock market selloff during February and March of 2020 was likely the biggest capital gain recognition period ever.
These are huge pools of money.
And it’s these pools of money that the Investing in Opportunity Act (IIOA) — passed in December 2017 as a provision of President Trump’s Tax Cuts & Jobs Act (H.R.1) — was designed to tap into for the benefit of some of the most economically distressed areas of the nation.
It does so by defining Qualified Opportunity Zones and by creating an entirely new investment vehicle to invest in such zones — the Qualified Opportunity Fund. And by providing three huge tax incentives for capital gains deployment into these new funds.
The capital gains tax benefits are explained in more detail in Chapter 4: What are Qualified Opportunity Funds?
(Download this guide as a PDF report… Click here.)
A brief history of the Investing in Opportunity Act
The Investing in Opportunity Act is bipartisan legislature, co-authored by Senators Tim Scott (R-SC) and Cory Booker (D-NJ) and Congressmen Pat Tiberi (R-OH) and Ron Kind (D-WI), and championed by nearly 100 congressional co-sponsors. It was initially introduced to both the Senate (S.293) and House (H.R.828) on February 2, 2017.
The Economic Innovation Group originally developed the idea in a white paper titled Unlocking Private Capital to Facilitate Economic Growth in Distressed Areas, published in April 2015. The paper — authored by Jared Bernstein of the Center on Budget and Policy Priorities, and Kevin A. Hassett of the American Enterprise Institute — makes no mention of “Opportunity Zones” or “Qualified Opportunity Funds,” but lays the groundwork for the preferential treatment of capital gains deployed to distressed areas of the country.
The Investing in Opportunity Act encourages investment in economically distressed communities by offering three huge tax incentives, which are detailed in Chapter 4 of this guide.
What is a low-income community?
The intent of the Investing in Opportunity Act is to funnel investment into low-income communities that have been long overlooked. But, what is a low-income community exactly?
The legislation defines “Qualified Opportunity Zones” as low-income census tracts that were nominated by each state’s governor and subsequently certified by the U.S. Treasury as Qualified Opportunity Zones.
For purposes of defining an Opportunity Zone, the term “low-income community” takes its definition from Section 45D(e) of the IRS Code, which states that a population census tract, in general, is low-income if:
(A) the poverty rate for such tract is at least 20 percent, or
(B) (i) in the case of a tract not located within a metropolitan area, the median family income for such tract does not exceed 80 percent of statewide median family income, or (ii) in the case of a tract located within a metropolitan area, the median family income for such tract does not exceed 80 percent of the greater of statewide median family income or the metropolitan area median family income.
There are a few caveats to this definition that deal with targeted populations, areas not located within census tracts, low-population tracts, and high-migration rural communities, which are explained in more detail in the code.
Some contiguous non-low-income community census tracts that lie adjacent to low-income census tracts are also designated as Opportunity Zones.
What is a contiguous non-LIC census tract?
Certain non-low-income community (non-LIC) census tracts were able to be designated as Opportunity Zones if they were:
(A) … contiguous with the low-income community that is designated as a qualified opportunity zone, and
(B) the median family income of the tract does not exceed 125 percent of the median family income of the low-income community with which the tracts is contiguous.
But no more than 5 percent of a state’s Opportunity Zones can be contiguous non-LIC tracts.
Qualified Opportunity Zone designations
The legislation called for the governors from all 50 states and U.S. territories, plus the mayor of Washington DC, to nominate Opportunity Zones from their jurisdictions. The governors could nominate up to 25 percent of their low-income census tracts.
An exception was made for states with fewer than 100 eligible tracts; these states were allowed up to 25 tracts to be designated as Opportunity Zones. Alaska, Delaware, the District of Columbia, Guam, Hawaii, Montana, North Dakota, Rhode Island, South Dakota, Vermont, and Wyoming were able to take advantage of this exception: they each have exactly 25 Opportunity Zones.
American Samoa, Northern Mariana Islands, and Virgin Islands each have fewer than 25 eligible census tracts. As a result, 100 percent of their eligible tracts were designated as Opportunity Zones.
Additionally, the 2018 Bipartisan Budget Act allowed for every low-income census tract and eligible non-LIC census tract in Puerto Rico to be certified as a Qualified Opportunity Zone. As a result, nearly the entire island of Puerto Rico lies within an Opportunity Zone.
The zone designations were finalized by the IRS in June 2018 and remain effective through the end of 2028.
More detail on Opportunity Zones can be found in Chapter 3.
The creation of the Qualified Opportunity Fund
To receive the preferential tax treatment that Opportunity Zone investing offers, investments must flow through a newly created investment vehicle — the Qualified Opportunity Fund.
Opportunity Zone funds can be structured as corporations or partnerships. They must invest substantially in 1) Qualified Opportunity Zone Businesses (QOZBs) that hold Qualified Opportunity Zone Business Property (QOZBP), 2) Qualified Opportunity Zone Property (QOZP) directly, or 3) a combination of the two. In general, a Qualified Opportunity Fund must hold at least 90 percent of its assets in QOZBs or other QOZP.
Certain “sin” businesses (golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetracks or other facilities used for gambling, and liquor stores) are ineligible for investment.
More detail on Qualified Opportunity Funds can be found in Chapter 4.
Chapter 3: What are Opportunity Zones?