There are many benefits to investing in Opportunity Zones (OZs). Investors benefit from postponing capital gains tax obligations, lowering taxes, and achieving competitive investment returns, while stakeholders in distressed communities benefit from capital investments that create jobs, improve access to services, and provide affordable housing.
With the Law on Tax Reductions and Employment of 2017, a new federal incentive was created for OZ, which is intended to encourage investments in undercapitalized municipalities. Any company or person with capital gains can qualify. Taxpayers postpone paying capital gains tax until December 2026. If the investment is held for five years at that time, the investor will receive a 10 percent tax break. At this point, if the investment has been held for 7 years, the base will be increased by 15 percent. Recent legislative proposals (The Opportunity Zone Extension Act of 2021) would extend the federal incentive until the end of 2028, which would allow taxpayers to defer taxes for two more years than current legislation allows. In addition, more investors could benefit from the 7-year base amount increase. Regardless of whether or not such a law is passed, the main tax incentive for OZ is to remove capital gains tax on the profit associated with the investment if it is held for 10 years.
While the tax incentive is a crucial element for investors, many are also motivated by the opportunity to invest in ways that are beneficial to society. The OZ initiative was created to bridge the gap that has grown between communities in our country since the great recession. This may be the main challenge facing our nation, and the effects of the ongoing pandemic have made it worse. The pandemic has raised awareness of these issues, and investors are finding that contributions to a Qualified Opportunity Zone (QOZ) fund, whether invested for the full ten or five years, are one of the over 8,700 in need advised zones in the USA benefit.
The impact on the market is significant
Opportunity Zones have attracted $ 75 billion in capital investments and are well on their way to lowering the poverty rate by 11 percent in the affected areas. This emerges from a progress report by the White House Economic Advisory Council (CEA), which was presented on August 24, 2020. Reducing the poverty rate in OZ could lift one million people out of poverty.
Previous investments have also created at least 500,000 new jobs in designated opportunity zone areas. Of the $ 75 billion in capital investment, about $ 52 billion would not have made it into opportunity zones without the incentive, according to the CEA. To produce the report, the CEA examined the Opportunity Zone’s investments and activities through the end of 2019.
The importance of compliance and reporting
The results so far are promising evidence that the OZ initiative is working. However, it’s early days considering that the final IRS guidelines weren’t available until late 2019. It is encouraging that new legislation is being proposed to expand the initiative, as the social improvements possible will take many years to reach their full potential. This is why it is so important for fund managers that compliance and reporting are top priorities.
Opportunity Zone funds have some unique reporting requirements that can seem complex. For example, every six months (June 30 and December 31) the fund must certify that 90 percent of the invested assets have been used in real estate in the Opportunity Zone. Once the money is invested at the property level, the fund must either pass the “original use” or the “substantial improvement” test. Once the fund has deployed capital down to the project level, the project has 31 months to actually use that capital. In addition, due to the pandemic, the IRS has adapted the guidelines to provide specific deadline extensions and working capital suspensions due to interruptions related to COVID-19 that may have delayed the funding, planning, approval and construction of projects. With all of this complexity and dynamic adjustments associated with adhering to the Opportunity Zone, fund managers should work with seasoned industry professionals.
Ultimately, however, the success or failure of the OZ initiative will be determined by its impact on communities in need. There is currently no obligation on fund managers to provide this type of reporting information and without this information there is significant debate about the positive or negative effects of the OZ initiative. Fortunately, there are solutions designed for the marketplace that can provide fund impact reports without being unduly burdensome or costly. The majority of fund managers are keen to have a positive impact on the community they invest in and some have already adopted such solutions. Those who have done this are likely to have a competitive advantage in the near future as the new administration assumes that these types of reporting requirements will become law and legislative proposals such as Senator Tim Scott’s IMPACT Act reporting plan will gain support.
Investors don’t want “impact washing”
The recent economic and social turmoil has largely accelerated the growth of impact investing. One of the great things about Opportunity Zones is that they can create a “double bottom line impact” by having a positive social and community impact while getting a high return on investment.
It is important for investors to understand the real impact of their dollar-for-dollar investment. You don’t want to invest in something that is impact washing, where the real impact of the investment has been overestimated, or where there are no transparency or accountability measures in place. To meet this demand, fund managers should include impact measurement in their ongoing reporting to investors and the community from the outset. That way everyone wins.
Reid Thomas is Chief Revenue Officer and Managing Director at NES Financial | JTC, the US division of JTC Group, a multi-jurisdictional fund, corporate and retail service provider.