Created to stimulate investment in distressed and low-income communities, Qualified Opportunity Zones (QOZ) have become a hot topic for real estate developers and investors. The program was enacted as part of the 2017 tax reform law that enable taxpayers to defer tax on eligible capital gains by making an investment in a Qualified Opportunity Fund (QOF), which in turn invests within QOZs. The U.S. government hopes the QOZ program will promote investment in low-income communities generating social, economic, and environmental benefits through new real estate projects and investments. The QOZ program is not the first of its kind, as other programs such as empowerment zones and new market tax credits have also provided similar tax incentives to attract new investment. Research on the effectiveness of these previous program has mixed results. Some findings suggest these programs have contributed to an increase in employment and a reduction in poverty, while others have indicated little or no economic and community impact (Kitson, 2019). As a relatively new tax reform, it is unclear as to whether QOZs have served as an effective stimulus spurring economic growth and development in underserved communities.
Making an equity investment in a QOF that invests in QOZs provides various tax benefits that differ from other tax incentives, such as 1031 like-kind exchanges and new market tax credits. In a 1031 exchange an investor can defer recognizing gains until the property is sold, at which point the investor would realize the full extent of their capital gain. In contrast, investing in a QOF allows investors to not only defer recognizing gains, but also to receive an exclusion of a percentage of the gain if the investment in held long enough (Rohde, 2019). Capital gains invested in QOFs are not subject to taxation if the investment is held for a more than five years. Initially, the program allows investors to exclude 15% of deferred gains from taxable income if the QOF investment is held for seven years. If the investment is held for five years, investors can receive a 10% reduction in tax on the deferred gain. As of December 31, 2019, investors can only receive a 10% reduction on the rollover gain. QOFs must also be certified according to IRS and Treasury regulations and must hold at least 90% of its assets in QOZ property. Investors have 180 days from the sale or exchange of assets to reinvest the gain in a QOF (The Joint Committee on Taxation, 2019). Additional limitations and qualifications must be satisfied for QOFs to be eligible for tax benefits. Investments must be made towards tangible property located in QOZ and made via a QOF. The property must be acquired by purchase and new or substantially improved within a 30-month period. QOFs need to be a partnership or corporation organized for the purpose of investing in QOZ property. The QOF must have 90% of its assets invested in a QOZ property (The Joint Committee on Taxation, 2019). Investors can also combine QOZ tax benefits with other tax benefits, such as new market tax credits, for the same investment.
QOZs were nominated by state governors and designated by the Secretary of Treasury. Eligible census tracts in every state must be considered “low-income communities” to receive QOZ designation (The Joint Committee on Taxation, 2019). Census tracts are semi-permanent and on average census tracts contain 4,000 inhabitants. With more than 8,700 designated QOZs, ample opportunities exist for investors to deploy capital into development projects in the designated QOZ communities that have high poverty, failing schools, and lack of job supply and investment (U.S. Department of Transportation, 2019). Many investors have taken advantage of this opportunity, including Normandy Real Estate Partners, who raised a $250 million fund for investments in low-income areas in the Northeast (Tan & Buhayar, 2018). Earlier this year, Fifth Third Bank announced that it would invest $100 million to develop projects in low-income urban and rural communities (“Fifth Third Bank Announces $100 Million Investment in Opportunity Zones”, 2020). The rise of investment in QOFs in the past year, with approximately $2.3 billion invested between early December 2019 and early January 2020, has heightened attention surrounding the effectiveness of the program in achieving its desired goals (Jeans & Larsen, 2020).
While QOZs have encouraged significant investment through various tax incentives available to investors, it is difficult to quantify and measure the impact made by QOF investment. Global Impact, an advisory firm, has developed a software to help measure investment in QOZs potential social, economic, and environmental impact (Larsen, 2020). Given the recent popularity of the program, there are many preliminary views on QOZs. Proponents argue that QOF investment has contributed to job growth and poverty reduction in communities. Others contend that QOZs have accelerated gentrification and displaced low-income individuals who were living in the designated QOZ areas (Weaver, 2018). The QOZ program has also faced harsh criticism for providing a tax break for affluent developers and investors with strong political connections (Jeans & Larsen, 2020). In fact, the US Department of Treasury recently launched an investigation into the Opportunity Zone Program to review whether some census tracts were selected illegitimately. At this point, loose requirements for investors to report the impacts of their projects in QOZ can be deceiving. That said, seeing as the program was just launched in 2017, it may be too early draw any definitive conclusions. More detailed reporting mandates may be necessary to accurately assess the impact of investment. It will be important to monitor the extent of QOF investments in QOZ and the resulting impact that these new projects have on the surrounding communities compared to previous programs and efforts.
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