Trump Tax Reform’s Opportunity Zones Yield Big Capital Gains Savings
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A new federal program will soon allow investors to save big money on capital gains taxes — if they’re willing to take a risk on economically depressed areas and lock up investments for five years or more.
State governors nominated up to 25 percent of their low-income community census tracts for federal Opportunity Zone status, and U.S. Treasury Department is in the process of reviewing and approving them.
For a map of zones that have been approved so far, click here. To download an Excel list of approved zones sorted by state, click on the third blue link on this page of the Treasury Department’s website.
President Donald Trump’s tax reform law created the Opportunity Zone program to let investors who roll capital gains into an Opportunity Fund defer tax payments until they sell their interest in the fund or the end of 2026, whichever occurs first.
The money must be invested in designated Opportunity Zones in distressed communities, which generally means household incomes are below the national average of $59,000 per year and the poverty rate is typically 20 percent or higher.
“I came out of one of these communities, so I believe that there’s untapped potential in every state in the nation,” Senator Tim Scott said in a January interview with Jim Tankersley, a reporter at The New York Times. The Republican senator from South Carolina was born into poverty and was a major advocate of that provision of the tax reform law.
$6 trillion potential
At stake is $6 trillion in potential investments nationwide.
That’s how much corporate balance sheets and U.S. households currently have in unrealized capital gains that may be eligible for these new investments, according to the Economic Innovation Group, a bipartisan public policy organization founded by entrepreneurs including Sean Parker, the billionaire creator of Napster and early Facebook investor.
Even if the actual amount that flows into Opportunity Zones ends up being a fraction of that, investments could easily top tens of billions of dollars, according to Congressional estimates.
“If it’s successful, we’ll look back 10 years from now and say this was one of the most important parts of the tax bill,” Kevin Hassett, the chairman of Trump’s Council of Economic Advisors, said in January after tax reform was signed into law.
18 states already approved
The U.S. Treasury Department in early April approved opportunity zone designations for 18 states, including Georgia, South Carolina and Mississippi.
All of the 260 areas in 83 counties nominated by Georgia Gov. Nathan Deal were approved. About 60 percent of the zones are in rural areas, and the rest are urban. Three of the zones are in Atlanta’s Norcross-Peachtree Corners area in Gwinnett County near I-85.
“By attracting more private investment to underserved areas, the tax incentives for Qualified Opportunity Zones will further encourage businesses to invest in the communities that need it most, while also creating meaningful employment opportunities across the state,” Deal said in a statement.
Here’s a map of all eligible census tracts that governors selected from to nominate Opportunity Zones in their state.
The Treasury Department is scheduled to complete the reviews and approvals of all the zones by the end of May.
How it works
Investors who have capital gains can roll that money into an Opportunity Fund, which will then invest in local businesses or projects such as multi-family housing developments that are an approved Opportunity Zone.
If investors keep their money in the fund for at least five years, they get an effective 10 percent reduction in tax owed on the rolled-over capital gains. Investments held for at least seven years get a 15 percent reduction.
To get the lowest capital gains tax rate, investors must keep money in the fund for at least 10 years. Doing so avoids capital gains taxes on the additional return from the Opportunity Fund investment, although investors still have to pay the original capital gains on money rolled into the fund in the first place.
For example, if capital gains of $100 million were reinvested in an Opportunity Fund in 2018, the after-tax value of the investment would be $109 million after 5 years, according to Economic Innovation Group, which helped shape the Opportunity Zone language in Trump’s tax reform law.
After seven years, that same initial $100 million investment would be worth $126 million and after a decade it would be worth $176 million, EIG estimates show.
Those scenarios assume a long-term federal capital gains tax rate of 23.8 percent, no state income tax and annual appreciations of 7 percent for both the Opportunity Fund and alternative investment.
“The largest incentive is reserved for patient capital that is in for 10 years,” said Kenan Fikri, director of research at EIG.
Already spurring investment
The program amounts to a “big tax break” for those willing to take a risk on economically depressed areas, Jack Manning, CEO of real estate investment firm Boston Capital, said at a recent industry event.
Deferred taxes could also help offset rising interest rates and construction materials costs, he said.
Civic leaders and investors across the nation are scrambling to identify projects that would qualify.
The regional airport in Middletown, Ohio, won Opportunity Zone status, which local officials hope will attract investment for a proposed drone school and an avionics maintenance business.
In Sunrise Beach, Missouri, city planners hope their new Opportunity Zone designation will woo investment in a retail center anchored by Woods Supermarket and incentivize affordable housing.
Before investors and community leaders begin setting up special government-approved vehicles called Opportunity Funds to make investments, they are awaiting guidance from Treasury on several key things the tax reform law didn’t explicitly address plus formal rules and regulations from the Internal Revenue Service.
Those questions include whether the sale of an Opportunity Fund asset within the 10-year window triggers a tax event even if the money is rolled back into that or another Opportunity Fund, and how long funds have to deploy money.
“Entities that have the intent and desire to set up a fund aren’t going to say anything publicly until they get answers to these questions,” Fikri said.
Certain administrative policies and procedures are also unclear, said Olivia Barrow, a policy analyst at Enterprise Community Partners, Inc., a nonprofit that advocates for affordable housing.
“The statute was pretty bare bones. There wasn’t much detail,” Barrow said. “The administrative infrastructure is in place to do this, but it’s a matter of teasing out how it’s going to be set up.”
Once investors and civic leaders gain clarity on the rules and procedures, which is expected before fall, investors, hedge funds, private equity firms, venture capital funds, community development financial institutions (CDFIs) and other groups should start setting up funds.
The first investments could occur before year’s end.
Investors can defer taxes on capital gains by rolling that money into newly created Opportunity Funds that invest in businesses or projects in approved Opportunity Zones in financially distressed areas.
Investments kept in the funds for at least five years receive an effective 10% reduction on taxes owed, while those kept for seven years receive a 15 percent reduction. After 10 years, investors won’t have to pay capital gains tax the proceeds of the Opportunity Fund investment – just the original investment that was rolled into it.
The Treasury Department is in the midst of reviewing and Opportunity Zones, and investors are awaiting guidance from Treasury and rules from the IRS to answer questions such as sale-and-reinvest scenarios that weren’t addressed in the law.
The first investments in Opportunity Zones may happen before the end of the year.
To learn more about how you can take advantage of new Opportunity Zones and other investment tax credits, contact Alison Fossyl, an Aprio partner and expert in commercial real estate and multifamily affordable housing.