[REN #520] New Huge Tax Incentive: Opportunity Zones

picture of map for Real Estate News for Investors Podcast Episode #520

Hidden in the depths of the tax reform package is a tax incentive program for real estate investors that’s just starting to get recognized. The “Opportunity Zone” program is designed to lure investors to areas that haven’t fully recovered yet from the Great Recession. In exchange, they can defer capital gains on the equity they use, and potentially eliminate it altogether.

Congress included the program as part of the Tax Cuts and Jobs Act that passed last December. Since then, all 50 states, the District of Columbia, and U.S. territories have had an opportunity to identify census tracts that they’d like to designate as Opportunity Zones or OZs.

Thousands of OZs Nationwide

There are more than 41,000 potential Opportunity Zones across the nation. That’s more than half the census tracks in the country, according to PSMag.com. Governors of the states and territories, along with the mayor of Washington D.C. were allowed to submit 25% of the tracks within their borders as potential Opportunity Zones. At the present time, 18 states have had their tracts approved by the Treasury Department. Treasury officials are in the process of finalizing the details for the rest of the tracts [1].

Unlike the Clinton-era “Empowerment Zones,” the new program gives states a great deal of freedom in steering investors toward tracks they feel need attention. Urban Institute’s Brett Theodos said, “We don’t have a lack of capital in the U.S. We have a lack of connectivity.” This program helps match areas that need investment to investors.

Connecting Investors to Communities

Theodos was in charge of an Urban Institute project to determine where investor money could do the most good. He said, some places “need more incentive than others” and it’s up to the decision-makers to pick wisely. Benefits to the community will depend on those choices.

Some analysts are concerned money poured into a neighborhood that is already gentrifying or on the verge of gentrifying could defeat the purpose to improve poor neighborhoods, if original residents end up displaced. And, gentrification is apparently happening in some of these zones. PSMag said, “there’s nothing preventing a state from parceling out its Opportunity Zone incentives to places that are already gentrifying, as appears to be the case in Cleveland.”

But, Opportunity Zones must also meet certain criteria. Under the rules, the nominated tracts must have a poverty rate of at least 20%. The median family income must also be no more than 80% of the median income in that region.

Local jurisdictions will be able to provide more details on specific Opportunity Zones, what the funding will pay for, and the potential benefits for investors. Investors may also be able to extrapolate on the benefits of different Opportunity Zones that offer similar asset classes. Bruce Katz, of the Brookings Institute, said investors won’t be dealing with entirely different opportunities from one tract to another. He believes, the OZ scenario will be a market that becomes more “routine.”

Texas Opportunities

In Texas, the Governor submitted more than 600 census tracts for approval by the Treasury Department. The Express News wrote, Governor Greg Abbott had help from city mayors who also provided a list of areas they felt needed investment dollars. The Governor created the final list based on several criteria. That criteria includes lower population density, chronic unemployment, and other issues affecting the economy such as Hurricane Harvey [2].

Abbott said in a statement, “This program will help highlight areas of Texas that are prime for business investment.” He said, “As we continue to recover from Harvey, these Opportunity Zone designations will also provide a much needed boost for local communities impacted by the storm.”

In the San Antonio, Bexar County region, the Governor submitted nominations for 24 tracts. He eliminated some suggested by Mayor Ron Niremberg and added a few others. Among those that were nominated are tracts in the East and West sides, downtown, Port San Antonio, the Brooks master planned community and the Northeast Corridor, as reported by Express News.

One councilmember said, the tract selection in the Northeast Corridor could lead to more development in an area that’s already on its way up. Recent improvements include: Morgan’s Wonderland, Toyota Field, and the Upton at Longhorn Quarry apartment complex. So the effect of the Opportunity Zones could improve the outcome of other nearby investment projects, as well.

So even if you didn’t want to invest in an OZ, you might want to be near one. Again, due diligence is required. That means investors will need to evaluate the possible risks and rewards of chosen tracts.

Investor Incentives & Benefits

As for the kinds of investments allowed, asset classes are pretty much wide-open. They are determined by the local governments which will set up the O-Funds for various projects or areas. Investors would then put money into the funds.

Asset classes could include things like infrastructure, small businesses, transit, affordable housing or rental housing. They would have to meet specific criteria, of course. For real estate, properties would probably need undergo substantial improvements.

Investors will benefit by using unrealized gains from a previous investment. Those gains are deferred during the investment period. If the investment is held for five years, the investor also gets a 10% step-up in basis. Investors get an additional 5% step-up in basis if they extend the holding period to 7 years. At ten years, investors get the 15% step-up in basis plus permanent exclusion for capital gains tax.

The Urban Institute Policy Center has been analyzing potential capital flows for various tracts and assigning each one an “investment score.” The analysis is based on four investment categories including commercial, multifamily, single-family, and small business. The analysis also includes a “socioeconomic change flag” or an indicator for the possibility of gentrification. That could include luxury development, property tax spikes, the displacement of low-income residents, and other results that the program is attempting to address.

There’s a vast number of investment opportunities, and many haven’t even been approved or publicized yet. We are looking for a guest to talk about this program on the Real Wealth Show in the coming weeks, so check back for that.

Links:

[1] PSMag Article

[2] Texas Opportunities: Express News

[3] Urban Institute Analysis

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