Opportunity Zone Investing

by: Michelle Sidle

In December 2017, President Trump passed the Tax Cut and Jobs Act of 2017. Senators Cory Booker (Democrat, New Jersey) and Tim Scott (Republican, South Carolina) co-sponsored this bipartisan legislation, which was championed by Sean Parker (the former President of Facebook) and Jamie Dimon (Chairman and CEO of JP Morgan Chase). This Act created a generous tax incentive for investors to deploy capital into distressed communities in the United States called Opportunity Zones. Opportunity Zones consist of 8,762 low-income census tracts covering 12% of the United States and 35 million people. They are located in all 50 states, the District of Columbia, and Puerto Rico. Capital inflows into these census tracts, produced via the tax incentives, are expected to produce meaningful social benefits such as job creation, reduction in unemployment, increase in median income, and reduction in poverty rate.

Under this Act, investors are incentivized to invest because they can defer, reduce, and even pay as little as zero taxes on potential profits if the investment is held for 10 years. This incentive is held in three stages. First, taxpayers with any capital gain can defer taxation on an unlimited amount of realized gains until the earlier of the sale of the investment of the year-end of 2026, if the gain is reinvested within 180 days into a Qualified Opportunity Fund. Secondly, taxpayers can reduce their capital gain liabilities associated with the sale if the investment is held. If it is held for between five and seven years, the reduction is 10%, and if it is held for seven years, the reduction is 15%. Thirdly, if the investment is held in the Qualified Opportunity Fund for ten years, investors pay no capital gains tax on new gains generated by a Qualified Opportunity Fund. This tax incentive provides investors with a finite opportunity, as the program expires in stages beginning in 2019 and ending in 2026.

As this legislation is so new, much of the regulation surrounding how to properly deploy this capital is being enacted as these capital transactions are being made. The IRS issued the two rounds of proposed regulations for the tax incentives in October 2018 (REG-115420-18) and April 2019 (REG-120186-18). The first package mainly proposed guardrails for investors in real estate projects, while the second laid out how the tax incentives would apply to operating businesses.

The Green Areas represent “Opportunity Zones” in Baltimore in which investors can allocate capital in exchange for tax incentives.

Regardless, under this tax incentive program, capital has already been invested and deployed into Opportunity Zones. Qualified Opportunity Funds can invest in eligible commercial, residential, mixed-used real estate properties and operating businesses located in Opportunity Zones. Certain types of operating businesses located in Opportunity Zones are not eligible for investment, including: golf courses, country clubs, gambling establishments, racetracks, liquor stores, massage parlors, and suntan and hot tub facilities. Such investment is often done in the hopes that it will produce large benefits to communities. However, there is much speculation to whether this tax incentive will foster such change. 

Of the 149 Census Tracts in Maryland designated as Opportunity Zones by the U.S. treasury, 42 of them are in Baltimore City. Most notably, Under Armour CEO Kevin Plank, in tandem with Goldman Sachs, has started deploying capital in the hopes of developing the Port Covington area. While this area is not traditionally an “Opportunity Zone”, as it qualifies for the benefits due to an overlap in mapping area which allows investors to gain access to the tax incentives, it is exciting to see this federal program overlapping in our own city. Baltimore City is actively working with investors, developers, businesses, communities, and other stakeholders to encourage business investments to revitalize the city.