The Opportunity Zone Program, created by the U.S. Tax Cut and Jobs Act of 2017, is meant to provide incentives for investment in low-income communities. An Opportunity Zone is a designated area, in which individuals can gain favorable tax treatment on their capital gains by investing those funds through a privately created Qualified Opportunity Fund (QOF). QOFs are managed entirely in the private market with the administration of the funds falling solely on the shoulders of fund managers rather than government agencies or investors.
How Opportunity Zones are Established
The Governors of each state can nominate up to twenty-five percent of their state’s low-income census tracts (LICs) to be designated as Opportunity Zones (OZ). In Massachusetts, there are 138 designated opportunity zones, including 137 low-income communities, plus 1 non-low-income contiguous tract. Forty-eight percent of the tracts are in “gateway cities,” which are municipalities with populations of 35,000 to 250,000 median household incomes below the Massachusetts average and average education attainment levels of a bachelor’s degree or above that is below the Commonwealth’s average. Rural communities make up eighteen percent of the communities with designated tracts.
Opportunity Zone Incentive Options
There are three incentive options for investors, which accumulate over the life of the investment. All three are federal incentives and are non-competitive, so all qualified investors may claim them.
- Temporary Deferral: Investors may defer capital gains on income reinvested into QOFs. The deferred gain must be recognized when the investor exits the fund, or on Dec. 31, 2026, whichever comes earlier.
- Step-Up in Basis: Investors can exclude 10 percent from capital gains tax for money invested in 2020 or 2021 and there are no exclusions for later investments.
- Permanent Exclusion of Fund Gains: If an investor keeps their investment in a QOF for 10 years, any gains from the QOF are exempt from taxation.
Opportunity Zones in Massachusetts
Governor Baker and his administration recommend that communities ensure that local permitting and zoning are conducive to the kinds of investments they aim to attract. In addition, communities may want to think about how to market the OZ to private investors within Massachusetts and beyond. This program comes with little oversight and bundles well with other programs, which is good in Massachusetts because of the housing shortage. Some of the additional programs the Commonwealth has that complement OZ development, such as MassWorks, Housing Development incentive Program (HDIP), and the Smart Growth Zoning Overlay District Act. Multifamily developments have accounted for 65% of all opportunity zone transactions in Massachusetts since the beginning of 2018, according to Reonomy data. Multifamily transactions were nearly 67% of all Fall River transactions in the same time frame and the figure was nearly 73% in New Bedford. The Wall Street Journal also reported that based on data for the first three quarters of 2018, property sales in the zones have spiked 80 percent, and land prices have risen around 50 percent over the same period.
Are the Rewards Worth the Risks?
While the benefits of OZs sound impressive, many investors and fund managers believe that the risk to stay in an OZ for over 5 years in order to get the minimum gain is not worth the reward. Some potential investors are concerned over the uncertainty of what a fund would invest in and the long 10-year period in order to leverage the maximum gain of tax-free returns. One of the biggest risks is the potential for a fund to become disqualified so that the investor no longer merits the tax break. One such disqualifier is the potential for an OZ property to undergo foreclosure. This would shift ownership of the property away from the QOF, meaning the QOF no longer meets the requirement of holding an OZ property. In summary, a troubled project can’t be recapitalized in a way that shifts equity ownership away from the QOF.
It is hard to read about Opportunity Zones without hearing both benefits and risks, and this can lead to some confusion. The National Association of REALTORS®, CPAs, and many tax consultants are great resources to use in order to gain more information about Opportunity Zones.