Tax Advisers Want More Clarity On The Future Of Opportunity Zones
When Congress passed the Tax Cuts and Jobs Act in December, it left many members of the commercial real estate community with uncertainty. Several clauses in the TCJA lack specification and clarity, leaving many looking for answers. Analysts have criticized the law for a series of glitches and typos that impose tax increases and stricter regulations on a number of business owners, while providing loopholes that benefit hedge funds and private equity firms. More than six months after the passing of the TCJA, the exact implications for the commercial real estate industry are still unclear.
One clause that will impact the way investors and developers do business is the creation of opportunity zones, found in section 13823 on page 130 of the tax overhaul. The provision incentivizes developers to build in low-income communities, or designated opportunity zones, across the U.S. to spur economic development and job growth. These zones are Congress’ attempt to stimulate the American economy through development in communities recovering from the recession. The concept has made many optimistic about the future of America’s most vulnerable communities, but tax advisers are worried the lack of clarity and the high level of risk could delay progress.
“I think everyone is pretty uncertain about what’s actually going to happen with opportunity zones,” RSM U.S. Director Paul Nadin said. “We’ve seen tax incentives like New Markets Tax Credits and Low Income Housing Tax Credits, but those are monetized. With opportunity zones, the incentive is a long-term investment, and these investors can only get returns after holding the investment for 10 years. The downside to this is I’m not sure how applicable that is going to be and if people are going to want to put money into a long-term investment, because it is risky and they could lose money.”
The opportunity zone concept was first introduced in 2015 by public policy firm Economic Innovation Group to help address the post-recession economic gap and the lack of growth in many American communities. It was reintroduced by South Carolina Sen. Tim Scott, who grew up in a low-income community in North Charleston.
“I had to explain it several times to folks,” Scott said to the New York Times. “I came out of one of these communities, so I believe that there’s untapped potential in every state in the nation.”
The opportunity zones concept is the first community development tax program introduced and signed into law since the Clinton administration. The incentive resembles several past initiatives aimed at repairing the economy in America and abroad. In the 1980s, Margaret Thatcher tested a similar concept by creating 11 enterprise zones across the U.K., offering grants and tax breaks to communities in need. This concept reinvigorated several struggling areas, including spurring transformation of Canary Wharf from a series of neglected docks to a thriving financial district. Witnessing this success, President Ronald Reagan adopted the practice in the U.S. The Clinton administration expanded on the concept in 1993 and developed empowerment zones, which offered tax incentives and grants to assist economically distressed areas.
“The overall goal for all of these programs is to try to spur job growth in these low-income areas,” RSM partner Craig Mason said. “In the past, these zones were targeting a few specific areas, whereas today the target areas are based on each state identifying which areas they want to designate.”
The program uses low-income census tracts as a basis to determine which areas qualify as opportunity zones. These are areas with poverty rates of 20% or more and a median family income of 80% or less of the area median income. In every state, up to 25% of census tracts that qualify can be designated as opportunity zones. Since economic needs can vary by state and region, it is up to the governor of each state to determine which tracts qualify as opportunity zones. Once these tracts are approved, they remain opportunity zones for 10 years.
“Until some additional IRS guidance comes out, I don’t know how useful the program will be yet, and there has been a lot of uncertainty regarding if neighborhoods even qualify,” Nadin said. “People hope that guidance will come out later this year, but no one is really holding their breath. For developers, the question will be what their investment is going to be, what kind of business they are investing in and if it is worth it.”
Many developers will be going into these communities regardless of whether they qualify as an opportunity zone, Nadin said.
“You may have a community where, for instance, there is an attractive housing market and you are going in and building apartments anyway,” he said. “The opportunity zones might be an additional sweetener to incentivize some people to invest, but it wouldn’t necessarily be the sole reason they would go into one of these communities.”
While many developers look at opportunity zones as a way to contribute to these areas from a social impact standpoint, it also has to make sense economically, Mason said. They want to have a positive influence on these communities, but it is important to determine the impact from a tax perspective. It can be a risky investment, and if the investment declines, developers and investors may suffer an economic loss.
“I think we are all cautiously optimistic at this point in time,” Mason said. “We don’t know any more about opportunity zones today than we did six months ago. There are no additional regulations that have been published, and we need that guidance in order to properly advise our clients. This initiative could be a great opportunity for community development, but nobody will know for sure until we have more clarity.”
This feature was produced in collaboration between Bisnow Branded Content and RSM. Bisnow news staff was not involved in the production of this content.