‘Opportunity Zones’ in tax cut bill offer big tax savings for real estate investors

GrowthSpotter contributor

Missing from the national media’s focus on political and macro-economic implications of this year’s tax cut bill was a provision designed to spur economic activity in distressed urban and rural areas.

The “Opportunity Zones” program, which is still being formulated by the federal government, could offer trillions of dollars in tax savings for real estate investors and the prospect of lower investment costs for developers and builders. The catch is the investment and development must be in certain zones designated by the state as needing economic assistance.

Here’s how it works: Investors can defer paying taxes on investment gains until either the sale date of an Opportunity Funds investment or Dec. 31, 2026, if they put the money into Opportunity Zone funds. Those funds must be invested in areas that have a poverty rate of at least 20 percent, or a median income not exceeding 80 percent of the surrounding metro area.

In addition to the tax deferment, investors can reap even larger savings by keeping their money in the funds for at least 10 years. After that date they can avoid paying all taxes on the sale or exchange of their investment in an Opportunity Zone fund.

Some experts estimate U.S. investors have more than $2 trillion in unrealized capital gains just from stocks and mutual funds alone. But local attorney Roman Petra, a tax and real estate financing specialist at Broad and Cassel, says the potentially available funds could be twice that number because gains generated from the sale or exchange of property -- not just capital gains -- are eligible for tax deferment in Opportunity Zone funds. 

“It can be art, stocks, bonds or it could be buildings,” he told GrowthSpotter. “If they have gains they have taxability on their money. They can put the money into a fund and defer the payment of taxes while money sits in that fund.”

The state of Florida designated 427 low-income areas as Opportunity Zones, including 39 in Central Florida. Among those are the Pine Hills and Parramore neighborhoods in Orlando, parts of Altamonte Springs, Apopka, Kissimmee, Poinciana and Sanford. The federal government has certified all those zones.

Officials at LIFT Orlando, a non-profit organization working to transform impoverished neighborhoods, said they participated in early conversations with the state to have downtown Orlando's West Lakes neighborhood designated as an Opportunity Zone.

"We are very happy Gov. Scott has identified our community as one that's eligible for Opportunity Zone fund investments,” Terry Prather, LIFT Orlando’s chief operating officer, said via e-mail.

"We hope to see additional investments from this program go towards our four pillars: affordable, mixed-income housing, cradle-to-career education, community health and wellness and long-term economic viability within the communities of West Lakes,” he added.

The state wanted to make sure that rural areas got a shot at the program’s stimulus, so economic development specialists made sure each of Florida’s 67 counties got at least one Opportunity Zone, said Erin Gillespie, deputy chief of staff of the Florida Department of Economic Opportunity

“We really tried to make sure that we were picking the areas that had the most need but also could provide a good return on investment,” Gillespie said. “We didn’t want to pick an area that people wouldn’t invest in.”

The Opportunity Zone program was structured to reward long-term investment in economic development in such target areas. For instance, if an investor puts his gain into a fund by Dec. 31, 2019, and keeps the investment for five years, he gets a 10 percent basis step-up, effectively reducing the taxes owed.

For example, an investor paying taxes of 20 percent on $100 in gains would, after five years, instead pay 20 percent on $90 of the deferred gain, which reduces the tax liability by $2.

If the investment remains in the fund for an additional two years, the investor gets an additional 5 percent step up in basis, so he would be paying 20 percent on $85 instead of $100.

“To get the full 15 percent (step-up in basis before taxes are due on the deferred gain by Dec. 31, 2026) you have to invest by Dec. 31, 2019,” Petra said. “That's why we’re trying to educate people now.”

The other important date comes 10 years after the investment. If you invest in an Opportunity Zone fund by Dec. 31, 2019, you would pay taxes on 85 percent of the deferred gain in December 2026. But if you keep the investment in the fund for 10 years, you pay no taxes on any appreciation above the original deferred gain. 

Those tax savings benefit investors, but they also indirectly help developers because of the potential for lower borrowing costs -- a significant factor in deciding whether to push a project forward in an area where income levels are lower and unemployment higher than more desirable neighborhoods.

“Most developers have (an idea of) how much money (costs),” Petra said. “Now they turn to these funds because of all the tax (benefits) you get to invest that money, so the money should be cheaper” for real estate development.

Questions remain about how effective the program will be as a profitable investment opportunity and an economic revitalization engine. Though the program does reward long-term investments, most large investors are looking to maximize their return. That’s why they like to invest in areas where money is already moving in.

Risk is also a factor in whether large investors choose to put money into Opportunity Zone funds. Many economic forecasters are predicting at least one, maybe two recessions in the next 10 years.

This presents a challenge in bringing economic development to outlying areas which are often more vulnerable to economic downturns.

“The issue with these outlying communities that could use these funds: Could they survive a downturn? If I was building a hotel, would I still have people visiting that community?” Petra said.

Unlike Orlando or Tampa, which have at least one and maybe several economic development organizations with paid staff, rural counties and communities at the farthest edges of large metro areas don’t have those advantages. Florida’s DEO is ready to step in and help those areas attract investment from Opportunity Zone funds, Gillespie said.

“In Hendry County they just don’t have expertise or staff for economic development,” that larger counties have, she said. “We will work with these rural communities to help them market themselves to businesses and investors that want to expand into those areas.”

Gillespie said the state has already seen interest in the program from investment groups, big and small, as well as from non-profit economic development organizations. But those groups are waiting on the Internal Revenue Service to give more guidance on rules for setting up Opportunity Zone funds. She said the feds have promised to put that guidance out this fall.

That’s a tight window for investors and their lawyers to set up the funds and find projects in which to invest. Year-end 2019 is the deadline to get the maximum benefits of the step up in basis on seven-year investments by the December 2026 mandatory payment date, and for the tax-free capital returns after 10 years. 

Investors who are thinking of selling investments don’t want to miss the top of the market, which some people think has already arrived or is approaching shortly.

“The key impediment is linking shovel-ready projects with investors who want to sell (property) now to gain from the top of the market,” Petra said. “They could put their money into Opportunity Zone funds, but ... the projects are not ready to ask for capital.”

Some critics have speculated that the funds might be used by wealthy investors to build high-end hotels or other expensive projects that won’t benefit low-income people who live in the Opportunity Zones.

But Tony Brown, president and CEO of the Tony Brown Consulting Group, said both the state and federal governments have done a good job of structuring the program and choosing a diverse array of zones, rural and urban, that are in critical need of projects that provide employment and housing.

Brown pointed to an analysis by the Economic Innovation Group of the census tracts chosen for Opportunity Zones by the nation’s governors.

“They were pleased about the diversity between urban and rural tracts that had a high level of unemployment and poverty,” said Brown, whose consulting firm works on financing of community development projects in Florida.

Brown said the Economic Innovation Group worked closely with Sen. Tim Scott, R-South Carolina, and Sen. Corey Booker, D-New Jersey, who drafted the bipartisan Opportunity Zone legislation.

“Sen. Scott and Vice President (Mike) Pence put together a group of blacks and whites and women to look at an early draft of the program to make sure the benefits of the program would go to a diverse group,” Brown said, “and that this would not be a program where just a few people benefitted but would be a program that reaches the highest areas of distress.”

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