Opportunity Zones: Beyond the Basics
Opportunity Zones are getting a lot of hype these days, and for good reason. They are designed to funnel $6.1 trillion into distressed communities through encouraging investment of capital gains and can be used to fund real estate investment as well as investment in businesses. Oh, and these investments need to happen by December 22, 2019 to realize the full benefit the program. (If you need a quick refresher on Opportunity Zones, check out the Economic Innovation Group’s FAQs).
Since being signed into law with the 2017 Tax Act, Opportunity Zones have already been used to fund real estate development projects. While investors have been quick to implement, the rest of us are still trying to figure out what Opportunity Zones mean for communities. Below, I explain important aspects of Opportunity Zones that you can take into your next meeting with investors.
New Regulations Create a Better Deal for Business Investing
Unlike many other federal economic development programs, Opportunity Zones are not being run through the Department of Commerce or the Department of Housing and Urban Development. Because they are, essentially, a tax break, the Internal Revenue Service is responsible for their administration. The IRS has been taking suggestions from leading experts in Washington and beyond to develop the guiding regulations for Opportunity Zones, and recently released the second tranche of regulations.
Of particular interest is that the so-called 50% rule has been changed. In an effort to prevent shell companies from exploiting tax breaks, regulators previously required that businesses receive half of their gross income from within their Opportunity Zone. While this may have worked for a grocery store, it would not support businesses that were hoping to manufacture a product to be sold widely.
But that has changed. According to Bisnow,
“Under the new set of regulations, a business funded by a qualified opportunity fund and located in an opportunity zone, could qualify for the tax incentives if it meets one of three "safe harbors": at least 50% of the hours the employees or contractors work are spent within the opportunity zone, half of the company's services are within the area or if the management and operations are based in the designated zones.”
The new regulations also clarify that investors will be allowed to invest in and sell a business as long as the proceeds are reinvested into another Opportunity Zone, and that real estate investors will be allowed to lease and refinance their properties.
Unfortunately, this round of regulations did not address critics’ concerns for more oversight, and did not introduce any ways for tracking investment in the Zones, or how to measure positive impacts for populations currently living in Opportunity Zones.
Opportunity Zones and Economic Development Administration Funds
Adjacent government agencies are also determining how their programs will interact with Opportunity Zones. The Economic Development Administration (EDA) has taken the step to open EDA funds to eligible entities within Qualified Opportunity Zones. This means that entities in Opportunity Zones applying for EDA funds via the 2018 Notice of Funding Opportunity for Public Works and Economic Adjustment Assistance Programs have an increased level of eligibility. According to a recent EDA blog post, since FY 2018, EDA has invested more than $13 million in 22 projects in Opportunity Zones to help communities and regions build the capacity for economic development.
If an Opportunity Zone in your area is facing a significant infrastructure challenge, EDA funds may be able to help. For example, EDA recently funded a $2.5 million replacement of flood infrastructure in an Opportunity Zone in the city of Dubuque, Iowa.
Marketing Your Opportunity Zones
Opportunity Zones are invested in by Opportunity Funds, which are run by investors, banks, and special interest firms. Targeting this wide ranging group requires a combination of collaborative strategic planning, marketing, and policy alignment.
A community driven strategic plan will help ensure that the current population’s needs and preferences are considered in the development of an Opportunity Zone. Fourth Economy has developed a planning process focused on community engagement; our Market Cards allow community members to take on the role of the developer or business owner, which leads to feasible, collaboratively designed strategic plans. This process results in a list of potential projects that have been vetted by both the community, and are financially feasible, thus forming a prospectus of investment that can be shared with Opportunity Fund investors.
Marketing for Opportunity Zones should happen on the city, region, or state level. So far, the most success in Opportunity Zone development has been through these larger entities promoting the Zones in their jurisdiction. For example, Colorado and Alabama have set up specific website that connects investors with properties and businesses in Opportunity Zones; Co-Invest, and Opportunity Alabama. Another best practice is to hire a coordinator specifically to oversee Opportunity Zones, as the City of Baltimore has done.
Finally, all city, state, and federal policies should be aligned. If your state has a capital gains tax, and does not allow for deferment in Opportunity Zones, that could dissuade investors. Novogradac has posted a map of state tax code conformity. On a local level, cities should aim for quick permitting, and instigate policies that will protect those already living in Opportunity Zones. For example, in an effort to slow rapid neighborhood change, Philadelphia freezes taxes for residents who have lived in their homes for more than ten years.