In 2015, the Economic Innovation Group (EIG), a bipartisan public policy firm, developed the Opportunity Zone concept, which was conceived as a systematic approach to helping address the uneven economic recovery and persistent lack of growth that have left too many American communities behind. The concept was introduced in the Investing in Opportunity Act (IIOA) during the 114th Congress, and reintroduced in the 115th Congress by Senators Tim Scott (Republican-South Carolina) and Cory Booker (Democrat-New Jersey) and Congressmen Pat Tiberi (Republican-Ohio) and Ron Kind (Democrat-Wisconsin), gaining nearly 100 congressional co-sponsors in 2017. This is the first new community development tax incentive program enacted since the Clinton administration, providing an opportunity for mainstream private investors to support businesses and distressed communities.
Opportunity Zones were enacted as part of the 2017 tax reform package (Tax Cuts and Jobs Act). In the broadest sense, the newly enacted federal Opportunity Zone program provides a federal tax incentive for investors to invest in low-income urban and rural communities through favorable treatment of reinvested capital gains and forgiveness of tax on new capital gains. The Investing in Opportunity Act (IIOA) promises to pump a massive amount of cash into America’s most impoverished communities by offering wealthy investors and corporations a chance to decrease or erase their tax obligations
With everyone’s focus on the recent drastic federal tax-rate cuts, the fate of the state and local tax deduction and the exploding federal deficits, it’s the least-known part of last year’s tax-cut law that could be the most consequential. It promises to pump a massive amount of cash into America’s most impoverished communities by offering wealthy investors and corporations a chance to erase their tax obligations. This economic and community development tax incentive program provides a new impetus for private investors to support distressed communities through private equity investments in businesses and commercial real estate ventures. The incentive is deferral, reduction and potential elimination of certain federal capital gains taxes.
Investors in the United States currently hold trillions of dollars in unrealized capital gains in the form of stocks and mutual funds. This is a significant untapped resource for economic development. If everything goes right, a big slice of the estimated $6.1 trillion of paper profits on American balance sheets could go toward revitalizing economically depressed communities. “If we can get the trillions of dollars of capital off the sidelines and get the best investment minds coming into our communities,” adds Cory Booker (Democrate-New Jersey), “we can end up creating jobs and opportunity.”
The engine to Opportunity Zones is a new breed of financial product, the Opportunity Fund, that offers investors attractive tax breaks. Here’s how it works. Investors who sell assets have 180 days to plow their taxable capital gains into an approved Opportunity Fund, which must hold 90% of its assets in Opportunity Zone projects. To put money to work fast, the law requires that the funds invest all of their cash within a specified time frame. Tax on the original reinvested gain isn’t due until 2026 and the taxable gain is cut by 15%. Meanwhile the new opportunity zone investment grows tax-free, like a Roth IRA, provided it’s held for at least ten years. If it’s sold earlier, it can be rolled into another Opportunity Fund and remain tax-free.
Unlike previous economic development incentives such as Enterprise Zones and New Market Tax Credits, which capped tax benefits and placed restrictions on the industries and regions you could invest in, the Investing in Opportunity Act is broad and scalable. Liquor stores, casinos, massage parlors are barred from participating. And while venture capitalists, private-equity shops and banks will be essential for launching Opportunity Funds, those firms can’t simply locate in an Opportunity Zone and grow tax free.
Funding can come from a host of sources including real estate developers, private equity funds, venture capital, investment banks, wealthy individuals, family offices and mutual funds. And there are many places for big money to go. Rural communities can host projects that need wide spaces, like farming, energy, mining, data centers and labs. Cities are likely to attract real estate developers, startups and venture funds.
The Opportunity Zones program offers 3 tax incentives for investing in designated low-income communities through a qualified Opportunity Fund:
A temporary deferral of inclusion in taxable income for capital gains reinvested into an Opportunity Fund. The deferred gain must be recognized on the earlier of the date on which the opportunity zone investment is disposed or December 31, 2026.
Step-up in Basis:
A step-up in basis for capital gains reinvested in an Opportunity Fund. The basis is increased by 10% if the investment in the Opportunity Fund is held by the taxpayer for at least 5 years and by an additional 5% if held for at least 7 years, thereby excluding up to 15% of the original gain from taxation.
A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in an Opportunity Fund applies if the investment is held for at least 10 years. This exclusion only applies to gains accrued after an investment in an Opportunity Fund.
For real estate developers, Opportunity Zones offer cheap real estate and unlimited, untaxed upside if a neighborhood takes off. Developers must do more than stash cash in crumbling property. To qualify for tax perks, they must make swift and significant upgrades – at least equal to the cost of the initial purchase. With real estate projects come new office buildings, industrial districts, restaurants and affordable housing ó all of which can lay the groundwork for an economic boom.
In Colorado, Opportunity Zones may help address a number of challenges:
- Promote economic development in parts of the state that have not shared in the overall general prosperity over the past few years
- Fund the development of workforce and affordable housing in areas with escalating prices and housing inventory shortages throughout the state
- Fund new infrastructure to support population and economic growth in Colorado
- Promote investments in startup businesses that have potential for rapid increases in scale and the ability to export their products and services outside the state of Colorado
- Upgrade capabilities of existing under-utilized assets through capital improvement investments in the state
Colorado’s Office of Economic Development and International Trade (OEDIT) conducted an inclusive and rigorous process to nominate census tracts for Opportunity Zone status. OEDIT produced metrics for evaluation, took public input and collaborated with regional economic development partners who brought extensive human intelligence to the table to select census tracts with need and opportunity characteristics that present a good case for private capital investment. Colorado’s Opportunity Zones present a portfolio of investment opportunities from urban to rural, from business startups to infrastructure. A majority of the census tracts are outside of the Front Range and touch much of the state with the goal of raising up our rural economies. The census tracts nominated have been approved. Colorado’s Opportunity Zones are now set for the duration of the program through 2026.
Unlike other economic development incentives, Opportunity Zones aren’t a program with a federal, state or local approval process for projects. Congress created some parameters ó for instance, investors can’t just buy a building in a zone, they must improve it. The program is designed to give investors a tax break simply by investing in a given area. To get the tax benefit, people must invest their capital gains in an Opportunity Zone Fund, which in turn invests in businesses or property in an Opportunity Zone. Investors can defer paying taxes on their gains right away. They earn a 15% tax cut on those gains if they hold on to their shares for 7 years. And if they hold on to their shares for 10 years, these same investors don’t have to pay income taxes on money they make when the shares increase in value.
Colorado has 126 census tracts designated as Opportunity Zones. 60% of those census tracks are in rural areas of Colorado. Private equity in Opportunity Funds will seek the best investment opportunities aligned with their missions and return requirements ñ it’s important to remember that Opportunity Zones in Colorado will frequently be competing with Opportunity Zones throughout the United States for capital investments.