What are opportunity zones?

This is Chapter 3 of The Ultimate Guide to Opportunity Zone Investing

An opportunity zone is a low-income census tract that has been nominated by its state governor and certified by the Treasury Department. The nation’s opportunity zones stand poised to receive a huge influx of investment, given the enormous tax incentives that the new legislation has created.

The Investing in Opportunity Act makes a big promise to these zones. But will the promises of economic growth (without too much resident displacement) come to fruition?

(Download this guide as a PDF report… Click here.)

Opportunity zone facts and figures

On June 14, 2018, the U.S. Treasury and IRS finalized certification of the opportunity zones. In total, 8,762 census tracts were certified as qualified opportunity zones. These zones are located in all 50 states, the District of Columbia, and all five inhabited overseas territories. In December 2018, Puerto Rico was granted two additional opportunity zones, bringing the total to 8,764.

A total of 8,534 out of 31,866 census tracts defined as low-income were designated as opportunity zones. An additional 230 eligible contiguous tracts (not defined as low-income) were designated to bring the total to 8,764.

Nearly 35 million Americans live in these zones, per 2015 American Community Survey data. The average poverty rate in the opportunity zones is 32 percent, compared to 17 percent for the average census tract.

Here’s the breakdown by state:

Opportunity zone ideals

By design, the Opportunity Zones program targets under-invested low-income communities on the margins — places where private investment would be highly catalytic. The very worst-off places in the nation are just not capable of attractive private investment. Conversely, communities already on an upswing would be a waste of program dollars.

As Annie Lowery puts it in The Atlantic, “Opportunity zones are meant to be Goldilocks-type places: not so distressed that no amount of government incentive would induce private money to them, not distressed but gentrifying and thus already seeing a flood of private money coming in.”

How to invest in opportunity zones

Taxpayers wishing to invest in opportunity zones are required to deploy capital gains in qualified opportunity zone funds. Opportunity zone funds are structured as corporations or partnerships and invest in qualified opportunity zone property.

What is qualified opportunity zone property?

OZ property can be one of two things — 1) an opportunity zone business; or 2) opportunity zone business property. An opportunity zone business can be structured as either a corporation or a partnership and must hold at least 90 percent of its assets in OZ property. Opportunity zone business property is tangible property used in trade or business of a qualified opportunity fund.

Opportunity zone property is explained in more detail in Chapter 4: What are qualified opportunity funds?

Opportunity Zones vs. NMTC

The most recent place-based economic policy is the New Markets Tax Credit program. Much of the opportunity Zones regulatory language is borrowed from the NMTC program, but there are a few substantial differences.

Program Mechanics

Each program was developed to incentivize capital investment in under-invested areas of the country. But there are key differences in the mechanics of how this goal is achieved.

Under the NMTC program, a taxpayer invests cash in a special financial intermediary termed a Community Development Entity (CDE), which then invests in businesses within a zone. Each CDE must be pre-approved by the Treasury Department and is required to provide governance rights to community representatives.

Under the Opportunity Zones program, there is much less oversight. A taxpayer invests capital gains into qualified opportunity zone funds, which then invests in businesses within a zone. But unlike CDEs, which must be pre-approved by Treasury, Opportunity Zone funds simply self-certify. There is zero pre-approval process, no community benefit requirement, and no requirement to provide governance rights to community representatives.

Tax Benefit

The tax benefit differs substantially as well. In the NMTC program, a dollar-for-dollar annual tax credit equal to the amount invested in a Community Development Entity (CDE) is granted to the taxpayer. But the taxpayer would still owe tax on any gains realized by the CDE.

But under the Opportunity Zones program, investors can deploy capital gains from any asset into a qualified opportunity zone fund. There are three tax benefits of this program: 1) deferral of capital gains tax until December 31, 2026; 2) reduction of capital gains tax due; 3) elimination of tax due on capital gains from opportunity zones investments.

Financial Impact

The NMTC allocates $3.5 billion in qualified equity investments annually. Conversely, the opportunity zones program has no limit to the amount of investment that can be made. Because of this, some believe that the opportunity zones program will dwarf the NMTC in terms of financial impact.

EIG’s fomer CEO Steve Glickman has called the opportunity zones program “the biggest economic development program in U.S. history.” And Treasury Secretary Steven Mnuchin believes there will be “over $100 billion of private capital” invested in opportunity zones.

Continue Reading

Chapter 4: What are qualified opportunity funds?