The Tax Cuts & Jobs Act of 2017 created something called “Opportunity Zones.” This is a brand new section of the federal tax code. An Opportunity Zone or “OZ” is an economically-distressed community where new investments may be eligible for preferential tax treatment. Communities must be nominated by their state for the designation and then certified by the Secretary of Treasury as an OZ.
The first OZs were designated in 18 states on April 9, 2018, and as of the beginning of June, 46 states and six territories/districts had submitted almost 8,000 census tracts to be designated OZs.
It is hoped that these zones will spur economic development and job creation in distressed communities. This is essentially a federal tax “carrot” designed to encourage development in these areas by providing tax benefits to investors. Included in the potential benefits will be (1) deferral of tax on any prior gains until the earlier of the date on which an investment is sold or exchanged, or December 31, 2026, so long as the gain is reinvested in a Qualified Opportunity Fund; and (2) if the investor holds the investment in the Opportunity Fund for at least ten years, the investor would be eligible for an increase in basis equal to the fair market value of the investment on the date that the investment is sold or exchanged.
Qualified Opportunity Funds
A Qualified Opportunity Fund (QOF) is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in an OZ and that uses the investor’s gains from a prior investment for funding the QOF.
To become a QOF, an eligible taxpayer simply self-certifies; no approval or action by the IRS is required. The taxpayer will complete a form (to be released by the IRS) and attach it to the federal tax return for the taxable year.
Impact on Affordable Housing
OZs are not specifically intended for housing production, but mixed-use (residential/commercial) and workforce housing have significant potential as OZ efforts. Affordable housing is in fact one of the activities specifically targeted in the new legislation.
Funds are now being formed and the first investments are expected by early 2019. The biggest current impediment to fund formation is timing; gain must be invested within 180-days of selling property and that may not work with the timing requirements of specific deals. Some potential participants are examining the possibility of bridge financing to deal with this issue.
Once these funds get off the ground, it is expected that real estate will be a prime area for investment. This is due to the fact that investors are going to want deals that appreciate in value and not those that are highly risky; real estate is a sound investment and many of the likely investors are already familiar with these deals.
While in its infancy, the OZ program offers potential for affordable housing developers, and may well provide another source of investors – including individual investors vs. corporate investors. In addition, since banks often have little if any gain to invest, new types of investors will be participating in the OZs, further creating the potential for new affordable housing opportunities.