Hidden beneath the $1.5 trillion of tax cuts that was signed into law in December 2017 is a tiny kernel of economic opportunity.
“Opportunity zones” are a concept promoted by an eclectic collection of disparate interests and politicians: Sen. Tim Scott (R-South Carolina), Sen. Cory Booker (D-New Jersey), tech mogul Sean Parker, the Economic Innovation Group in D.C. and congressmen from both parties. The base idea is to incent investors to redirect their gains into investments in economically challenged neighborhoods. The concept borrows elements from 1031 exchanges, which allows investors to avoid taxation by reinvesting gains in like kind properties; and from new markets tax credits, which direct capital to economically disadvantaged communities. Added to those are some distinctly new features, such as partial tax-gain forgiveness (over time – in years five and seven), a bye on future gains from the investments (after 10 years) and broadening the types of eligible investments to include virtually any kind of economically helpful activity.
While there are geographic constraints – unlike almost all other federal subsidy programs – there are no dollar limits as to the amount of gains that can qualify. Moreover there are no requirements ensuring that the investments benefit low-income people in the community. Companies and real estate are eligible investments (although substantial rehab is needed for existing buildings). In theory, of course, this capital would otherwise not necessarily be going to these communities – and increased economic activity in these areas is perhaps benefit enough.
But will investors come? And in sufficient numbers?
Complicated Considerations
The program is complicated, and it is not yet clear whether its benefits are enough to outweigh its complications. There is a need to find investors seeking to shelter gains. Will they be individuals (a daunting set to find, herd, market to and manage) – or will it be financial corporations (such as banks and insurance companies)? There are timing complications. The investments need to be done within 180 days of the gains being realized. The qualifying investments need to be ready, identified and convincing enough to outweigh the post-tax alternatives. And there are investment horizon considerations; the real opportunity zone benefits come from holding the investments 10 years (to capture the bye on future gains) – a fairly small subset of the investing world.
In addition, today’s new tax rates are relatively low. There is a meaningfully different inducement when marginal tax rates are 35 percent (pre-December, 2017) than it is when they are 21 percent ( after December 2017). And there is an implicit bet that taxation rates will not be higher in the future (marginal tax rate increases in the future, from today’s historically low rates, could easily wipe out other benefits).
It is too early to tell whether investors will have significant appetite for these investments, whether they will be made and whether they will have the desired impact. On balance, however, it never seems prudent, where taxes are concerned, to underestimate the power of creative minds.
W. Bart Lloyd is managing director of acquisitions and general counsel for the Preservation of Affordable Housing Inc., a Boston-based housing nonprofit with a national focus on affordability preservation.
