2 Years In … Now What?
By Harding Easley
Investors have been paying close attention to opportunity zones since the creation of the Tax Cuts and Jobs Act (TCJA) in 2017. That legislation created a series of tax incentives that set investors around the country on a course to change the plight of almost 9,000 distressed communities throughout the United States. However, the launch of the program came with a healthy dose of ambiguity – enough to keep developers and investors busy finding gray areas among the silver lining of the nation’s opportunity zones. It appears early complications are not dimming investors’ enthusiasm for opportunity zone investments as the legislation passes the two-year mark.
The conventional wisdom has been that the tax benefits from qualified opportunity zone investments would help to spur economic growth while also encouraging long term investments for developing distressed tribal, rural, suburban and urban communities nationwide. When the program first went into effect in 2018, there were many issues that arose around qualified investments and eligibility for participation in the program. The U.S. Treasury Department made their final rules in December 2019. The 544-page report has helped investors navigate the choppy waters on which the program initially began.
Investors Refused to Abandon Ship
Despite early confusion, accredited investors have, as yet, refused to abandon qualified opportunity funds (QOFs). Current investors sit proudly on a three-leveled captain’s chair of tax incentives: an initial tax deferral, partial elimination of capital gains taxes, and the potential for complete elimination of capital gains taxes on QOF appreciation if the investment is held for at least 10 years.
Today, investor enthusiasm for the program has certainly not waned, nor has political affection for the legislation. As of February 2020, the National Council of State Housing Agencies (NCSHA) opportunity fund directory listed 203 funds expected to raise more than $40 billion for opportunity zone investments. This past December’s final governance on opportunity zones could be exactly what was needed to raise awareness and further increase interest in the program!
An Important Change in the Final Edition
A change worth noting in the final rules is the period for investing gains. No longer will the clock start ticking at the end of year in which assets were sold. Now, the clock starts on the date of sale. This means capital gains from the sale must be invested into a QOF within 180 days of gain recognition in order to defer or potentially eliminate capital gains taxes.
Furthermore, effective January 1, 2020, the initial 5 percent reduction in the appreciation capital gains tax expired. Investors can still access a 10 percent reduction, however. Time will tell if investors begin to question opportunity zones as a viable option due to the loss of the first tier of tax advantages.
Meanwhile, developers are currently applauding the new guidelines finally making it across the finish line. There are a number of positive changes and clarifications that will make opportunity zone raises more productive. For example, if a developer purchases a building in an opportunity zones for $2 million, they no longer must match the volume of the initial investment and invest another $2 million in renovations. Instead, they can allocate part of that money toward renovating another building in proximity to the first or toward ground-up development. This is likely to accelerate investment activity in opportunity zones.
Public-Private Partnerships Could be Key to Alleviating Housing Affordability Woes
With these new regulations and clarifications in place for opportunity zones, the public-private partnership marriage should definitely renew its vows. The layered approach to tax incentives in opportunity zones has created a pulse in the life in the growing affordable housing shortage. Opportunity zone investments could represent a more palatable solution to rent controls or skyrocketing rents.
While opportunity zone developments will not be a cure-all for all concerns associated with the national shortage of affordable housing, they could play a major role in the progress of providing more affordable housing especially as part of a larger development. For example, new construction of multifamily properties in opportunity zones represents significant potential in easing the shortage of affordable housing.
However, it will be important for public and private parties to be flexible. Strict timelines and local, state and federal government red tape do not mix well. A strategy of development that includes partially affordable units, along with a larger development and layered tax benefits from multiple government sources, may place investments in a zone – an opportunity zone.
In the meantime, investors will likely continue to invest in QOFs and monitor the progress of current projects. Will future reports from the White House Opportunity and Revitalization Council reveal a positive impact the opportunity zone program has had on the shortage of affordable housing? If the next few years determine such an outcome the opportunity zone ship will have then truly reached its destination.
Harding Easley is the managing director of The Harding Group, LLC, a comprehensive consulting firm specializing in the identification of gaps and opportunities in investment strategies and businesses. Learn more at TheHardingGrp.com or email Harding at heasley@thehardinggrp.com.