A new national tax program to encourage investments in low-income areas has more details emerging about how it works.
The U.S. Department of the Treasury in October gave a clearer definition to how opportunity zones will function. Taxpayers can now invest capital gains, such as the sale of stocks or real estate, into opportunity zones for a tax deferral within a certain time period.
Over six months after the program launched, one law firm already has begun to oversee opportunity zone investments, and a local development company is testing the waters in Kansas City before starting opportunity zone projects in Springfield.
Through the Tax Cuts and Jobs Act of December 2017, opportunity zones were created through the Treasury and the Internal Revenue Service to incentivize development and job creation in distressed communities. Springfield has three opportunity zones on 10 census tracts in center city, north Springfield and an area surrounding Bass Pro Shops.
“The public policy benefit of this is private money going into distressed areas, not tax dollars,” said Shawn Whitney, a partner at Spencer Fane LLP. “We should encourage it as much as possible.”
Spencer Fane is representing $50 million in investments in opportunity zones, which Whitney thinks could spur some $300 million in project development at the firm’s Kansas City and Springfield offices.
“Over the next calendar year, it’s going to really be active,” he said on opportunity zone funding. “Where I’m seeing the activity is on the real estate side. You’re seeing projects in opportunity zones receiving the benefit of additional capital on development, redevelopment and new development. That doesn’t mean we won’t see investment in operating businesses.”
He said he has investors looking to invest into opportunity zones.
“I have many development projects in opportunity zones that we’re working on,” Whitney said.
One potential Springfield investor is O’Reilly Development Co. LLC. While the company is currently working on two projects in Kansas City in opportunity zones, officials say they could look to Springfield next.
“From an investor model, we would definitely look in our own community first for an opportunity to reinvest capital gains,” said Denise Heintz, a partner at O’Reilly Development Co. “Although we have not identified any specific opportunities in Springfield opportunity zones, O’Reilly Development is always interested in pursuing new development in their hometown and will thoroughly look at defined opportunity zone areas.”
The company is currently developing a senior community center in southwest Kansas City, which has $7 million in equity, and a market rate multifamily facility in the concept stages in north Kansas City that’s expected to raise close to $1 million in equity, Heintz said.
“The benefits to our equity campaigns is that this increases the internal rate of return for investors, so they are very interested in it,” she said. “It gives a boost anywhere from 25 and 35 percent higher returns than a like property outside the zone.”
An eligible taxpayer has 180 days from the date a capital gain was realized to invest in either a qualified opportunity business or a qualified opportunity fund, according to the Treasury.
Funding can either be direct or indirect in opportunity zones, according to a joint document by the IRS and Treasury Department. Direct funding is an investment into a qualified opportunity business, while indirect funding utilizes a qualified opportunity fund to disperse dollars to businesses within an opportunity zone. A qualified opportunity fund must hold at least 90 percent of its assets in qualified opportunity zone property, according to IRS rules.
Investors can defer capital gains through 2026, by investing in opportunity zone funds. Opportunity zones carry the designation for 10 years.
“Right now, it’s a lot of interest and inquiry,” said Sarah Kerner, the city’s director of economic development, of local businesses within opportunity zones. “It’s a pretty sweet deal for them, if the owners have capital gains they can reinvest.”
The city has not tracked how many businesses are located within the opportunity zones, she said, noting the city’s involvement only was in writing the application for the federal program.
“It’s completely driven by private activity,” Kerner said.
If the investment in a qualified opportunity fund is held for five years, the investor gets a 10 percent tax deduction. A seven-year investment nets a 15 percent tax deduction, according to the IRS and Treasury.
“You’re only paying capital gains tax on 85 percent of your initial investment,” Whitney said. “If you hold your investment for a period of 10 years, every dollar of appreciation is effectively forgiven.”
A corporation or partnership can self-certify to become a qualified opportunity fund by filling out a form with its federal income tax return, according to program materials from the Treasury. Limited liability companies and pre-existing entities also can organize as qualified opportunity funds.
Certain businesses cannot apply to be a qualified opportunity zone business: golf courses, country clubs, massage parlors, liquor stores, and hot tub, suntan and gambling facilities, according to the IRS and Treasury.
The IRS and Treasury Department are scheduled to release additional guidance before the end of the year, and Whitney said a few items could be clarified moving forward.
For instance, he said it’s unclear if dollars can be moved from one fund to another.
With the December 2026 cutoff date, he said investors may not be able to fully capitalize on the maximum five-, seven- and 10-year benefits.
“There’s a liquidity issue there,” Whitney said, adding he would like to see the deadline set at a rolling seven years from an initial investment.
Another possible issue is the handling of metric tracking and oversight.
No Treasury or IRS documents reviewed by Springfield Business Journal outlined any tracking systems for the opportunity zones. Both organizations are providing legal guidance, regulations and education to assist investors, according to the IRS website.
The departments created a list, IRS Section 1400Z-2, identifying the opportunity zones in the United States, but there is no database of investors or projects.
Previously established funding programs, such as new market tax credits and enterprise zones, require tracking of metrics, like job creation. Opportunity zones do not currently carry the same requirement.
There is no governmental oversight on qualified opportunity funds and no cap on the number of funds or dollar amount they can hold.
“Obviously, you have to comply with law,” Whitney said, adding oversight comes through audit risk.
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