Governors have submitted designations for Opportunity Zones as part of a new federal incentive program that promotes real estate and business investments in high poverty neighborhoods by favorably taxing capital gains. This new incentive creates a substantial opportunity to direct much-needed capital into distressed areas, but big questions still remain regarding how the program can and should be used to achieve critical economic development goals.
In conversations with our clients, we sensed considerable curiosity and interest about this new investment vehicle, and its ability to promote growth and opportunity in communities that desperately need new investment. We thought it would be helpful to provide insight on opportunities and challenges that should be considered when using this tool.
What are Opportunity Zones?
Established in December’s rewrite of federal tax law, the program is still in its initial stages of implementation, and federal regulations are still pending. But the broad strokes are simple, taxpayers can defer paying capital gains taxes by investing those gains into Opportunity Funds, which invest equity into businesses and property within Opportunity Zones – low-income census tracts designated by each state’s Governor and subject to approval by the IRS.
An Incentive that Plays Well with Others
In its current form, nothing precludes investors and local governments from mixing existing incentives, like New Market Tax Credits, Historic Tax Credits, or Low-Income Housing Tax Credits with investments through an Opportunity Fund. Additionally, Opportunity Funds appear to be very flexible in terms of eligible investments, including real estate, infrastructure, affordable housing, or even a new transit extension. While there could be future guidance offered on this topic, public and private community development professionals should consider Opportunity Funds as a uniquely-flexible new tool in their financing toolbox.
Local Government at the Helm
Cities won’t be the only places with Opportunity Zones, but as leaders of the movement to create smarter, efficient, and better monitored place-based revitalization, they are particularly well-positioned. Cities can guide the direction of this new source of investment capital to address multiple bottom line objectives by:
- Establishing their own Opportunity Funds
- Using Opportunity Funds to support long-term development strategies
- Focusing new investment in affordable housing, infrastructure, and small business development to catalyze long-term community and economic development goals.
Thinking Equitably: Early and Often
This program was designed with investors in mind, and its success will depend on whether they consider the risk of investing in a distressed area worth the reward. Already, cities like Cleveland are seeing nominations of census tracts in quickly gentrifying areas of the city, where arguably development would have continued without the use of any new public incentive.
However, it is extremely important to the health and sustainability of a city’s economy to ensure residents and businesses in Opportunity Zones receive balanced benefits from this investment without the threat of involuntary displacement. Nothing in the Opportunity Zones legislation provides protection against speculation and runaway gentrification. Cities will need to carefully monitor the pace and character of change in Opportunity Zones and have policies and programs in place to ensure that existing residents and small businesses share in the benefits of revitalization. These may include targeted hiring and small business participation programs, initiatives that remove barriers to workforce participation, flexible loan programs, and capital directed to new housing that is affordable to low- and moderate-income households.
While there are many outstanding questions about this provision of the Tax Act will translate into new investment in distressed areas, it isn’t too soon for investors and public and private economic development professionals to think creatively about using it. What other opportunities do you see in Opportunity Zones? For more information, contact Paul Silvern in HR&A’s Los Angeles office.