When the U.S. federal tax bill was passed late last year, an incentive was quietly included that could now have major ramifications for real estate development nationwide, particularly in major cities. It’s called the Opportunity Zones Program, and for developers and investors, there’s the ability to reap significant tax benefits.
The idea behind opportunity zones is for each state to designate up to 25% of its eligible census tracts as to be opportunity zones. Investors who put money into these areas can see a variety of tax benefits, designed to spur more development and interest in underserved areas and communities. The brainchild of the Economic Innovation Group, it’s estimated that this program could funnel as much as $6 trillion into communities most in need nationwide.
At the California level, the goal was to try and focus on the following main points when designating its 879 census tracts:
Focusing on poverty, but also account for median income. Initially, California designated many college campuses based on low student income, but many residents mentioned how these weren’t appropriate choices.
Focus on distribution. With their own metrics, as well as listening to recommendations and following contiguous tracts, the state accounted for 57 of the state’s 58 counties.
Account for both residential and primarily business tracts to encourage diversity of investments.
Many city planners and officials see the potential of this program as well. Long Beach Deputy Director of Economic Development Sergio Ramirez mentioned how the interest the program could potentially bring some life into struggling neighborhoods. “This will be a tool to induce investments,” he explained. “Luckily, the city doesn’t have to do anything. We don’t have to take a vote. It’s already in place. Investors could just come in.”
So, how do these tax benefits work out? To double or potentially even triple-down, investors sell some of their appreciated assets, like stocks or real estate, and put capital gains into opportunity funds, also known as O-funds. The first tax break they get is that their gains tax will be deferred for several years. For example, a deferral in 2018 would go into 2026. In addition, when they are taxed in 2026, they will get a 15% reduction on those taxes. Additionally, if held for at least 10 years, they will experience tax-free growth on their investment.
Combine these together with the versatility of development options (anything in an opportunity zone that isn’t considered a vice by Congress), and you start to see why Opportunity Zones are being talked about. Frankly, opportunity funds could suddenly become an asset class in and of itself.
Caution, however, is prudent as this program is still in its infancy are there are still questions as to its application. Tax advisory specialists are popping up. That said, it’s clear that opportunity zones may encourage real estate developers and investors to take deeper looks at areas that have not been on their radar. And that, in the minds of the creators of the program, was the ultimate intent.