Some 8,700 census tracts across the United States have been designated as Federal Opportunity Zones, and 2019 will be the year Opportunity Zone Funds are created and the “low-hanging fruit” for this new program are picked. While Opportunity Zones are very young, four tactics will drive them to be a source of economic development growth in 2019.
The federal tax reform created the new “Qualified Opportunity Zone” program. The Qualified Opportunity Zone program is designed to encourage investment in businesses that are located in low-income communities by permitting a taxpayer who recognizes gain on the sale of property to gain certain tax benefits. Federal Opportunity Zones offer three tax incentives to investors: a temporary tax deferral for capital gains reinvested in an Opportunity Fund – the deferred gain is recognized on the earlier of the date on which the opportunity zone investment is sold or December 31, 2026; a step-up in basis for capital gains reinvested in an Opportunity Fund – the basis of the original investment is increased by 10% if the investment in the qualified opportunity zone fund is held by the taxpayer for at least 5 years, and by an additional 5% if held for at least 7 years, excluding up to 15% of the original gain from taxation; and a permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in a qualified opportunity zone fund, if the investment is held for at least 10 years.
The US Treasury Department will certify who is a “Qualified Opportunity Fund,” but the tax reform law defines this as a partnership or corporation formed for the purpose of making investments in businesses located in low-income communities designated as “Qualified Opportunity Zones.” To gain the program benefits, an investor must invest proceeds from a sale or exchange of assets to an unrelated party into a Qualified Opportunity Fund within 180 days from the date of such sale or exchange. This investor may choose to reinvest only a portion of the proceeds from the original sale or exchange, in which case only a portion of the gain would be deferred. A Qualified Opportunity Fund is required to invest at least 90% of its assets in targeted businesses where substantially all of the tangible assets of each such business are used in a Qualified Opportunity Zone, and at least 50% of the gross income earned from each such business is from the active conduct of business in a Qualified Opportunity Zone. Opportunity Funds provide investors the chance to put that money to work rebuilding the low-income communities.
The IRS draft regulations released on October 19, 2018, are being reviewed and will be finalized early in 2019. Today, communities and companies have been moving forward with creating Opportunity Zone Funds. The PA Flagship Opportunity Zone Corporation was developed to identify deal flow, identify local funds, connect with developers and investable business opportunities; work with economic development organizations and professionals, and connect local investors, lenders, bankers, and service providers. Louisville, Kentucky offers another example of a high-quality Opportunity Zone prospectus for a larger region. Also, the Detroit Opportunity Fund was announced in June of 2018 and it will invest in newly designated opportunity zones in the Detroit Area. The fund is reportedly beginning with a $500-million pipeline of new deals in the city. Finally, state governments in Illinois, Kentucky and other areas are working on organizing statewide Opportunity Zone programs and debating state policy changes to support their growth.
2019 will be the year not only that the IRS Opportunity Zone regulations are finalized, but look for a number of other activities to launch in this important new economic development tool:
Creation of Regional Opportunity Fund Prospectus. The early efforts of Erie, Pennsylvania and Louisville, Kentucky will be copied all over the U.S. in 2019. Regions and states will move forward with organizing their opportunity zone sites into a neat digital and print package that markets these sites as well as the region’s workforce, tax code and infrastructure in place ready for economic development. Quality Opportunity Fund prospectus will provide detailed site plans and a tax incentive strategy that has been adopted at these sites.
State Opportunity Fund Public Policy. States like North Carolina have already adopted new state public policy and tax incentives to support the growth and development of their state’s Opportunity Zones. North Carolina will not be alone by the end of 2019 as state governments across the Union meet to address public policy and budget issues and new tax policy and tax incentives will be debate and adopted. Also, states like Illinois and Kentucky have been organizing their state Opportunity Zones, and these two states will also be joined by governors all across the nation to build a true statewide program for the owners and economic development leaders at the local level.
Real Estate Opportunity Fund Creation. Built around individual real estate projects like multi-family housing, high-tech and office projects, Opportunity Funds will be created in 2019 focused solely on individual real estate projects. The planned growth of multi-family projects in urban centers driven by a Millennial residential market also supports the early-adopter tag for urban multi-family and other real estate projects that likely were already planned with the Opportunity Fund program was created. Larger regional and state Opportunity Funds will arise but likely will not do so until the IRS regulations provide greater clarity for large scale global investment to occur in the Opportunity Zones.
Tech Investors. Venture capital investment in US companies hit $100 billion in 2018. With many new unicorns valued at $1 billion-plus, countless $100-million venture financings, and an explosion of giant funds, it’s no surprise that 2018 shaped up to be a banner year for venture capital investment in U.S.-based companies. Big venture capital investments lead to big profits for tech investors. These investment profits create substantial capital gains in the tech sector and will likely make these investors the early players in the Opportunity Fund investor world. Banks, with their large layer of federal regulations, will likely be the last to invest in Opportunity Funds and, as the IRS regulations settle outstanding questions, insurance companies will become better targets for Opportunity Fund investors.
Opportunity Zones are likely to be a source of economic development in 2019 with more economic prospects to come in years to come.
David J. Robinson is Principal of the Montrose Group, LLC, whose firm provides corporate site location, economic development planning and lobbying services across the United States and is an advisor on and national speaker on the federal Opportunity Zone program.