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Opportunity Hidden in the New Tax Law
Posted on February 26, 2019 April 8, 2019 by ccsmith50
Photo Credit: https://www.camoinassociates.com/opportunity-zone-update-find-your-community-interactive-map
By: Alex Townsley
Benjamin Franklin has been credited with once saying, "[I]n this world, nothing is certain except death and taxes."[1] Americans are reminded of the truth of the latter certainty every year during tax season, but this year, along with the usual pains of preparing one's taxes, taxpayers are grappling with understanding the effects of the Tax Cuts and Jobs Act of 2017.[2] However, there may be some unexpected relief in the form of a new program called "[O]pportunity [Z]one[s]."[3]
What is an Opportunity Zone?
In a recent letter to the Treasury Secretary, members from both houses of Congress and political parties described the Opportunity Zones tax incentive as "deliver[ing] transformational impact, including new jobs and higher wages, in low-income areas throughout the country, many of which have been left behind by the national recovery after the Great Recession."[4] But what is an opportunity zone? In short, an opportunity zone is an economically troubled area that under certain circumstances offers investors preferential tax treatment for new investments in that community.[5] Before an area can be used for this purpose, it must be designated as a "qualified opportunity zone."[6] I.R.C. § 1400Z-1(a) defines a qualified opportunity zone as "a population census tract that is a low-income community that is designated as a qualified opportunity zone."[7] To become a designated zone, four criteria must be met: (1) the area must be low income; (2) the area must be nominated by the chief executive officer of the state for opportunity zone status; (3) the chief executive must notify the Secretary of the Treasury of the nomination; and (4) the Secretary of the Treasury must certify the nomination and designate the zone within the consideration time period.[8] Once an opportunity zone has been certified and designated, any investment made in the area through a properly recognized fund is eligible for preferential tax treatment.
Why invest in an Opportunity Zone?
Under the new tax law, capital gains that are invested in qualified opportunity zones can be sheltered from taxation.[9] To make this investment, the funds must be placed in a "qualified opportunity fund" defined as "any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property . . . that holds at least 90 percent of its assets in qualified opportunity zone property . . . ."[10] These opportunity funds are managed by private fund managers with little oversight from the government once established.[11] To ensure the opportunity funds maintain the required 90 percent investment within the opportunity zone, a penalty can be imposed on the fund for each month its assets fall below the threshold.[12]
As an investment vehicle, an opportunity fund can be either a partnership or corporation based on the wishes of the investors.[13] This flexibility, along with the fact that investors need not live in the opportunity zone they wish to invest in, opens the door for taxpayers seeking preferential treatment.[14] Once a fund becomes a qualified opportunity fund, a potential investor can invest in an existing business, real estate, or new projects that fall within a qualified opportunity zone.[15] However, the investment must be made into something acquired after January 1, 2018, and not in something the fund owned prior to that date.[16]
How are Opportunity Zones different from traditional private investment?
Unlike traditional private investment, which may have qualified the investor for a tax credit, the Opportunity Zone program operates under new Internal Revenue Code sections.[17] As a product of these new rules, the capital gain invested is treated differently by the IRS.[18] Unlike previous tax programs targeting the same investors, there is no cap on the amount of capital that can be invested in an opportunity fund.[19] Furthermore, the longer the investments stay in the fund, the greater the tax benefit for the investor.[20]
The Future of Opportunity Zones
As of now, the reaction to the Opportunity Zone program established by the Tax Cuts and Jobs Act of 2017 has been mixed. This mixed response comes from many factors. The first and foremost of these factors is that the program has yet to be fully examined by tax professionals and investors alike.[21] Despite this uncertainty, over 8,700 qualified opportunity zones have been designated in the country, including zones in all fifty states, the District of Columbia, and five U.S. Territories.[22] Skeptics of the program point to zones in areas that would have attracted investment anyway.[23] Other criticisms include the arguably hard nature of quantifying the benefit gained from opportunity funds.[24] Regardless of where one falls in his opinion of the program, at a minimum, the program highlights areas of the country that are falling behind and creates an opportunity for those communities to thrive again.
[1] Benjamin Franklin's Last Great Quote and the Constitution, Nat'l Const. Ctr.: Const. Daily (Nov. 13, 2018), https://constitutioncenter.org/blog/benjamin-franklins-last-great-quote-and-the-constitution/.
[2] Darla Mercado, The New Tax Law Has a Bunch of Changes. Here's What You Need to Know as Filing Season Begins, CNBC (Jan. 28, 2019, 4:41PM), https://www.cnbc.com/2019/01/28/-heres-what-you-need-to-know-about-the-new-tax-law-as-filing-season-begins.html.
[3] See I.R.C. § 1400Z-1(a) (West 2018) (introducing opportunity zones).
[4] Letter from Tim Scott, Senator, United States Senate, et al. to Steven Mnuchin, Secretary, United States Dep't of the Treasury (Jan. 24, 2019) https://www.scott.senate.gov/imo/media/doc/1.23.19%20Signed%20Opportunity%20Zone%20Letter%20to%20Secretary%20Mnuchin.pdf.
[5] Opportunity Zones Frequently Asked Questions, IRS (Jan. 11, 2019), https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions.
[6] I.R.C. § 1400Z-1(a) (West 2018).
[8] I.R.C. § 1400Z-1(b) (West 2018).
[9] Devin Thorpe, Opportunity Zones Investors Receive Needed Guidance for Measurable Impact, Forbes (Feb. 11, 2019, 9:00AM), https://www.forbes.com/sites/devinthorpe/2019/02/11/opportunity-zones-investors-receive-needed-guidance-for-measurable-impact/#732d89b27cc1.
[10] I.R.C. § 1400Z-2(d)(1) (West 2018).
[11] What are Opportunity Zones and How do They Work?, Fundrise, https://fundrise.com/education/blog-posts/what-are-opportunity-zones-and-how-do-they-work#why-created (last visited Feb. 17, 2019).
[12] I.R.C. § 1400Z-2(f)(1) (West 2018).
[13] Opportunity Zones Frequently Asked Questions, IRS (Jan. 11, 2019) https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions.
[15] Erin Arvedlund, Opportunity Zones: Rules Finally Come Out, and Yup, They're Complex (But Manageable), The Inquirer (Jan. 7, 2019), https://www.philly.com/business/opportunity-zone-20190107.html.
[17] What are Opportunity Zones and How do They Work?, Fundrise, https://fundrise.com/education/blog-posts/what-are-opportunity-zones-and-how-do-they-work#why-created (last visited Feb. 17, 2019); See I.R.C. §§ 1400Z-1 to 1400Z-2 (West 2018) (codifying the Opportunity Zone program).
[19] Sarah O'Brien, Heard the Buzz About Opportunity Zone Funds? Here's the Skinny, CNBC (Nov. 1, 2018, 10:42 AM), https://www.cnbc.com/2018/10/31/heard-the-buzz-about-opportunity-zone-funds-heres-the-skinny.html.
[20] See I.R.C. § 1400Z-2(b)-(c) (West 2018) (discussing investments made in opportunity zones).
[21] Joshua Pollard, 3 New Hints Emerge on Final Opportunity Zone Rules, Forbes (Feb. 11, 2019, 7:45 AM), https://www.forbes.com/sites/joshuapollard/2019/02/11/3-new-hints-emerge-on-final-opportunity-zone-rules/#27e09282f140.
[23]Sarah O'Brien, Heard the Buzz About Opportunity Zone Funds? Here's the Skinny, CNBC (Nov. 1, 2018, 10:42 AM), https://www.cnbc.com/2018/10/31/heard-the-buzz-about-opportunity-zone-funds-heres-the-skinny.html.
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