20 Questions with Opportunity Zones: The lowdown on the program you can’t stop hearing about
Aside from the controversial corporate tax cut, Opportunity Zones are one of the most highly-discussed aspects of the 2017 Tax Cuts and Jobs Act within the real estate industry. Here, you’ll find the answers to 20 of the most valuable questions regarding Opportunity Zones to help you better understand their potential to affect you, your business, and/or your community. Should any of these questions pique your interest, you’ll find links to relevant articles that dive deeper into the topic. Opportunity awaits!
1. What is the policy context for Opportunity Zones?
Opportunity Zones are a place-based policy: they target underperforming geographic areas by funneling resources or creating financial incentives to support development within certain jurisdictions. By contrast, people-based policies direct similar support to individuals experiencing socio-economic distress. The former has been highly criticized for its inability to confront the historical policies and structural inequality which have produced those conditions. They also can contribute to gentrification and displacement, let alone the difficulties they present in measuring causal impact; however, the growing disparity between geographies, at both neighborhood and regional levels, has reinvigorated support for the tool, particularly at the federal level. With broader technological, economic, and geopolitical shifts sweeping the nation (er, globe) and continuing to drive spatial inequality, the limitations of people-based policies are evident.
Suggested reading:
● Econofact - Do Place-based policies work?
● CityLab - A Guide to Successful Place-Based Economic Policies
2. What other place-based policies have we tried in the past?
The United States has experimented with comparable designations in the past. In the ’90s, Empowerment Zones, Enterprise Communities, and Renewal Communities maintained similar motivations and utilized similar strategies, such as block grants, employment tax breaks, and other investment incentives. According to the Heritage Foundation, several studies reveal the limitations of place-based policies as well: the Congressional Research Service could not directly identify nor attribute general improvement in the outcomes of targeted communities to these policies. When compared to the public and private costs associated with Empowerment Zone incentives, marginal job and wage growth reveal the program’s economic inefficiency. Moreover, other studies have shown designations did not significantly inform investment decisions and the resulting increased property values were positively correlated with higher poverty in some cases. Bottom line? These kinds of policies have garnered ambiguous success at best and fostered regressive outcomes at worst.
Suggested reading:
● HUD - Capturing Successes in Renewal Communities and Empowerment Zones
3. For fellow Virginians, what were the outcomes like for these programs in the Old Dominion?
Virginia’s Enterprise Zone, a similar but not identical program, yielded some positive results. It’s important to note that the Virginia Enterprise Zone program differed from the Opportunity Zone program in that the state made use of grant incentives instead of tax credits beginning in 2005. These incentives included Job Creation Grants and Real Property Improvement Grants (RPIG) for businesses located in 30 designated zones. A report run by the Virginia Department of Housing and Community Development found a high correlation between RPIG grant disbursement, business development, and job growth. This indicates the potential for real estate investment such as new construction and renovation to create jobs and attract businesses to designated zones. Furthermore, property values increased by 21% in zones between 2006 and 2015. Although an indication of a worthwhile investment for real estate companies, unless the aforementioned job growth found its way to original zone resident income growth, gentrification and displacement are inevitable. For comparison, property values grew just 4% within a quarter-mile outside the zones revealing the ways in which these policies can fundamentally alter the socio-economic landscape of our communities.
Suggested reading:
● VA DHCD - A Review of the Virginia Enterprise Zone Program
4. How do Opportunity Zones fit into this context?
Opportunity Zones are a place-based policy designed to direct investment to economically disadvantaged communities through preferential tax treatment. Each of these zones meets the 2012-2016 American Community Survey’s criteria for a Low-Income community. About 56% of US census tracts (42,176 tracts) are eligible for the program, partially because higher-income communities adjacent to qualified tracts can qualify too, so long as the median income does not exceed a certain threshold. Overall, these communities are characterized by lower incomes, home values, rents, and rates of homeownership, as well as higher unemployment, populations of people of color, and poverty rates.
Suggested reading:
● International Revenue Service - Opportunity Zones FAQ
● Enterprise - Need Help Understanding the Opportunity Zones Eligibility?
● Economic Innovation Group - Opportunity Zones - Facts and Figures
5. If half the country qualifies, how were these zones selected?
The process for zone selection was quite open-ended. As previously mentioned, any Low-Income Community qualified. In addition, contiguous tracts with median incomes that did not exceed 125% of the qualifying tract’s income also qualified. The governor of each state and territory, plus the mayor of DC, then selected up to 25% of these eligible tracts. In the end, 8,762 tracts—about 12% of total US tracts— became designated Opportunity Zones. Of them, the vast majority (8,532) were Low-Income Communities while far fewer (230) were contiguous communities. Each state took the liberty to customize their process within the boundaries of these broad parameters. These rigorous selection methods involved consulting local authorities, national experts, non-profits, potential investors, citizen advisory committees, and additional analytics. In total, Opportunity Zones represent 35 million people across the four territories, DC, and all 50 states.
Suggested reading:
● Economic Innovation Group - Opportunity Zones: The Map Comes Into Focus
● Tax Policy Center - What are Opportunity Zones and how do they work?
6. What are Qualified Opportunity Funds?
Qualified Opportunity Funds (QOFs) are the investment vehicle for Opportunity Zones. They receive preferential tax treatment, reducing— and in some cases eliminating— capital gains taxes when used to finance applicable projects within Qualified Opportunity Zones. These can range from commercial and industrial real estate, housing, infrastructure, and business projects. Any individual can take advantage of the program, including C corporations, S corporations, partnerships, trusts, estates, regulated investment companies, and real estate investment trusts. There are just a handful of projects you can’t use the QOF to finance: golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, race tracks, gambling facilities, and businesses selling alcohol for off-site consumption.
Suggested reading:
● Forbes - Tax Geek Tuesday: Reaping The Benefits Of Investing In An Opportunity Zone
● Forbes - IRS Releases Latest Round Of Opportunity Zone Regulations: Where Do We Stand Now?
7. What are the incentives that encourage the use of QOFs to invest in OZs?
Through QOFs, the program channels investment into Opportunity Zones using three different tax incentives, activating the money without immediately triggering a capital gains tax:
1. Investors can place existing assets with previously earned capital gains into a QOF without being taxed until December 31, 2026, or upon sale of the investment.
2. If these capital gains are held in the QOF for five years, the investor receives a 10% basis step-up; If the investment is held for seven years, the investor receives a 15% basis step-up and thus excludes taxation on up to 15% of the original deferred gain.
3. Investors earn permanent exclusion of taxable income if the investment is held in the QOF for 10 years. This only applies to gains accrued through the QOF, not initially deferred gain.
Suggested reading:
● Fundrise - What are the Tax Incentives of Investing in Opportunity Zones?
8. How do investors use a QOF to benefit from the program?
First, the individual taxpayer recognizes capital gains on the sale of an asset. This asset must be sold after December 22, 2017, and before January 1, 2027. There is no “like-kind” requirement, so the sale of any type of property is eligible. Then, the taxpayer reinvests some or all of that gain in a QOF within 180 days of the sale and reports the rollover using IRS Form 8949. You do not have to invest the full amount of the sale, just the amount equal to the gain. As described above, the length of time for which you hold the investment determines when, how much, and if your capital gains taxes are due. The longer you wait, the less capital gains you pay.
Suggested reading:
● Fundrise - How to Roll Over a Capital Gain Into an Opportunity Fund
9. What are Qualified Opportunity Zone Properties and Qualified Opportunity Zone Businesses?
Both are the qualifying assets of a QOF. Grant Thorton explains that Qualified Opportunity Zone Property (QOZP) can be new construction or renovated existing property mostly located in an OZ. For new construction, the original use must begin after December 31, 2017. For renovations, the property must be “substantially improved” over a 30-month holding period. Regulations state that 70% of the property must remain in the opportunity zone for 90% of the period.
Qualified Opportunity Zones Businesses (QOZB) are those in which 70% of the tangible property owned or leased is QOZP; 50% of gross income comes from business conducted in the OZ; 40% of the intangible property supports that business conducted in the OZ.
Suggested reading:
● Grant Thornton - New Opportunity Zone Rules Answer Pressing Questions
10. What are the details of improvement requirements for property investments?
The substantial improvement provision applies to redevelopment and renovation projects. Withum indicates taxpayers must double their adjusted basis in the property after purchase during any 30-month period that they hold the QOZP. In other words, renovations to existing buildings must equal that of the building’s value; However, land value is not considered in the calculation. This significantly reduces the amount developers must invest to satisfy the “substantial improvement” provision, especially in urban areas where land values increase property values tremendously. This does not apply to property that is vacant for more than five years. In this case, the original use would begin once the property is placed into service and thus not activating the substantial improvement requirement.
Suggested reading:
● Withum - Substantial Improvements to Opportunity Zones
11. What about the program makes it so unique?
The main difference between opportunity zones and its historical counterparts, as well its most attractive quality to investors, is the extent of the tax benefit. Forbes pointed out that by holding your investment in a QOF, you could yield a 30-40% increase in annualized return. There are no limitations on how much money a single investor can pass through the program; and, the lack of traditional restraints, such as like-kind requirements or project specifications, only increase the program’s flexibility. Bloomberg reports Opportunity Zones have the potential to mobilize more than $100 billion of capital flows in target neighborhoods across the county.
Suggested reading:
● Barron's - Opportunity Zones: A Closer Look at the Tax Incentives Risks and Reward
● Stanford Graduate School of Business - Will “Opportunity Zones” Lift Neighborhoods Out of Poverty?
● Bloomberg - Mnuchin's $100 Billion Market Gets Boost With Rules on Tax Break
12. Where are Opportunity Zones located?
Below you’ll find several online and interactive maps to explore Opportunity Zones. You can’t glean too much information from a distance, but the mapping tools linked below allow you to look up any address to see if it falls within a designated Opportunity Zone. According to the Economic Innovation Group, over 75% of the selected Opportunity Zones are located in metropolitan areas but are split relatively evenly between higher and lower density tracts. Moderately dense tracts complete the picture, indicating a balanced mix of urban, suburban, and rural selections.
Suggested reading:
● Economic Innovation Group Map
● The Opportunity Zone Database - Virginia Map
● Virginia Economic Development Partnership Map
13. What impact could selections have on outcomes?
Each state’s selection strategy was designed to support localized goals, ensure geographic proportionality, and maximize the program’s effectiveness in reaching those communities most in need; However, findings from the Urban Institute show policymakers may not have accomplished their goals. In comparison to all eligible tracts, UI found that 28% of the selected communities already have some of the highest rates of access to capital in terms of commercial, multifamily, single-family, and small business lending. This data is problematic considering the program’s major goal: to bring capital to where it is lacking, not where it is most prevalent. Many of these communities were already experiencing indications of gentrification, including increases in households with college degrees, median family incomes, non-Hispanic white residents, and average housing cost burdens. In fact, UI found more selected tracts (3.2%) experienced these socioeconomic changes between 2000 and 2016 than their eligible but non-designated counterparts. These indicators reflect an already increasing level of vulnerability that exists for low and mid-income residents in many Opportunity Zones.
Suggested reading:
● The Urban Institute - Did States Maximize Their Opportunity Zone Selections?
14. How are we measuring the impact of this program?
Originally, there was no reporting framework built into the legislation that allowed policymakers to track the program’s impact. This major critique of an already controversial policy strategy forced federal attention. In May 2019, bipartisan congressional leaders introduced legislation requiring investors to report a wide variety of information to the Department of Treasury. This includes the number of QOFs held, the number of assets being held in QOFs, the composition of QOF investments, the impact on OZs (job creation, business start-ups, etc.), economic sectors in which businesses operate, and several other metrics. It cannot be understated how important tracking this information is to the ultimate evaluation, transparency, and effectiveness of the program. Unfortunately, the proposed legislation is not yet law.
Suggested reading:
● Forbes - New Opportunity Zone Reporting Requirements Aim To Measure Social Impact
● State Tax Notes - An Analysis of the Policy's Implications
● Tax Foundation - Measuring Opportunity Zone Success
15. What are the other major critiques of this program?
Real estate investment will increase property values. Given the aforementioned somewhat arbitrary selection process, this could exacerbate ongoing gentrification in zones and increase the potential for displacement. This phenomenon may hurt existing businesses in zones too as subsidized firms may outcompete unsubsidized firms. There is also no requirement that the jobs created must align with the skills of current residents. Thus, it is possible that potential job growth is felt primarily by skilled and mobile workers living outside zone boundaries. If pre-planned projects receive tax breaks for investments that were likely already going to be made, no additional economic activity will reach Opportunity Zones; And, it is impossible to ensure tax breaks reach unplanned projects only. This supports the notion that place-based strategies simply shift rather than generate economic activity.
Congress’ Joint Committee on Taxation reports that opportunity zone tax incentives will cost around $1.5 billion per year. Although some revenue will be recouped once capital gains become due, many argue the lost revenue could be spent directly on housing, education, and transportation that more directly benefits zone residents. The legislation’s framework disconnects investors from the community, without holding them accountable to local leadership, development priorities, and equity concerns. It is difficult to compare what would have happened absent the Opportunity Zone program because an undesignated “control” zone may not exist for comparison. Each locality has the flexibility to establish other programs simultaneously, limiting the extent to which we can evaluate the policy’s impact.
Suggested reading:
● Forbes - Opportunity Zones: We’re Doing It Wrong
● The Tax Foundation - Opportunity Zones: What We Know and What We Don’t
16. What are proponents' responses to these critiques?
Financially, there is money to be made in opportunity zones, especially in real estate. The tax incentives provided and flexibility ensured reflect a truly powerful investment opportunity. In Opportunity Zones, the cost of doing business is higher than that of more economically thriving areas. This is driven by a number of factors including a lack of skilled labor, reduced transportation access, and higher crime rates. Opportunity Zones bring employment to those who are unable to seek opportunities elsewhere while offsetting the cost of doing business in that area. In response to the lack of direction from localities, it can be argued that this increases the ability for jurisdictions to tailor the program to its needs through additional incentives, land-use designations, and development planning. Moreover, if many of these communities are already experiencing gentrification and thus attracting investment, the policy cannot be entirely blamed for spurring gentrification. More fundamentally, the program offers the classic supply-side theory that Opportunity Zones will create jobs, increase the local tax-base, support other universal economic goals for struggling communities.
Suggested reading:
● Next City - Now’s the Opportunity for Cities to Work on Their Zone Defense
● Washington Post - Opportunity Zones: Can a tax break for rich people really help poor people?
17. What are some ways to maximize the potential positive impacts of OZs?
States can play a hugely important role in setting the framework for the program, increasing transparency, and guiding localities. McKinsey suggests they publish findings on websites, coordinate departments, provide mayoral support, and facilitate implementation through HUD. Above all, it is crucial that potential investors understand the local context and identify projects that are needed in these communities. States can help coordinate these efforts by acting as a liaison between residents, stakeholders, and investors. Several states such as California, Kentucky, Arizona, and New Jersey have created digital tools and investment prospectuses where investors can determine appropriate projects and sites. At the local level, it is crucial that jurisdictions enhance the public services available, add additional incentives (tax abatements, credits, grants, loans, etc.) and organize strategic plans for implementation. Local programs such as job training workshops can help increase the number of residents prepared for job openings in target neighborhoods. Foundations can have a role too: a donation from the Rockefeller Foundations pays for positions that will help guide local implementation.
Suggested reading:
● McKinsey - Making the most of US opportunity zones
● Ohio Economic Development Agency - 5 Strategies to Prepare Opportunity Zones for Development
● Washington Business Journal - D.C. gets $920K Rockefeller Foundation grant for opportunity zones
18. What role can investors play in ensuring the success of the program?
Impact investors, Georgetown University, and the Federal Reserve Bank of New York proposed guiding principles within the voluntary Opportunity Zone Reporting Framework. The guidelines include community engagement, equity, transparency, measurement, and outcomes to develop socially and environmentally responsible projects. There’s a reason some kinds of projects, like golf courses and country clubs, are off-limits. By learning more about neighborhoods and including communities in the development process, investors are more likely to put together projects that generate a win-win situation for stakeholders. A few ideas for appropriate projects that also support the investor agenda include student housing, shopping center redevelopment, multifamily housing, experiential retail, industrial development, medical offices, lab space, and event centers.
Suggested reading:
● Strategies for Opportunity Zone Investors
19. What projects are using the program and are underway right now in the DMV?
The program is so new that few Opportunity Zone projects have been made public. Many investors site the delayed passage of final regulations as responsible for the hold-up. As one of the lucky cities to receive funding from the Rockefeller Center,
Although most investors are still in the fund-raising stage, a few examples of local OZ investments include a mixed-use development called City Market at O, a 262-unit multifamily community on 19th ST, a New Carrollton metro development, and a last-mile industrial project in Prince George’s County. Time will tell how Maryland and Virginia Suburbs follow.
Suggested reading:
● Globe St. - Opportunity Zone Project of the Year
● Multi-Housing News - EJF Capital Backs $95M DC Development
20. I’ve weighed the pros and cons. Where do I get started?
To create a QOF, you must be an accredited investor with a net worth of $1 million or maintain two consecutive years of $200,000 in an annual income. According to Kiplinger, most funds also maintain a $100,000 investment minimum. Novogradac, the National Council of State Housing Agencies, and the Opportunity Zone Database have directories for existing QOFs. We would also recommend looking to see if there is an investment prospectus for your locality of interest. These resources, along with other tools that can help guide your investment decision, are linked below.
Fund Directories
● NCSHA - Opportunity Zone Fund Directory
● Novogradac - Opportunity Zones Resource Center
● Opportunity Zone Database Opportunity Zone Fund Directory
DMV Resources
● Washington, D.C. - Opportunity Zones
● DC Opportunity Zone Marketplace
● Arlington Economic Development - Opportunity Zones
● Fairfax County - Opportunity Zones
● Loudon County Economic Development - Opportunity Zones
Strategy
● Enterprise - Opportunity Zone Explorer by Opportunity360
● Think Advisor - An Opportunity Zone Fund Checklist for Advisors
● Opportunity Zone Investing: Is It for You?
● Bigger Pockets - Flash Guide to Setting Up a Qualified Opportunity Fund
Other