‘Opportunity Zone’ Investment Rules Likely This Month from IRS

Investment fund managers may get answers soon on how to recycle capital gains into projects in low-income areas deemed “opportunity zones” in exchange for a new tax break.

The incentive, part of last year’s tax overhaul (Pub. L. No. 115-97), has drawn a lot of attention from investors and could tap into an estimated $6 trillion in idle capital gains, according to an analysis of Federal Reserve data by the Economic Innovation Group, a public policy organization based in Washington that is involved in promoting the program.

Investors see Internal Revenue Service regulations as critical before they seek to lower capital gains taxes by putting money into projects.

Program rules could come out before the end of October, Sen. Tim Scott (R-S.C.), a primary force behind the program, told reporters Oct. 10.

When asked about the amount of investment he expects in opportunity zones, Scott said, “I’ve heard upwards of $50 to $80 billion. Some have suggested it will be three digits—so it would be a $100 billion investment in the next couple of years, which I think will be realistic.”

The proposed rules are now with the Office of Management and Budget’s Office of Information and Regulatory Affairs, the last stop before the proposed rules are kicked back to the IRS and made final.

Revenue Cost Revised

The Joint Committee on Taxation recently updated its revenue cost of the tax incentive, increasing it to $9.4 billion over the next five years from last year’s estimateof $7.7 billion, an indication that the IRS and Treasury are recognizing industry interest in the program.

The increased estimate is an indication that the government expects more money to be poured into opportunity zones from 2018 to 2022, Michael Novogradac, managing partner at Novogradac & Co., told Bloomberg Tax. Based on the reduced capital gains tax rates, this translates to “well over” $40 billion invested, he said.

“It is exciting to see the revised score, as it signals that investor interest in opportunity zones is greater than initially projected, which means even more equity capital investment in distressed areas,” he said.

The tax incentive aims to drive investment dollars into low-income areas to spur economic development in the form of jobs and business opportunities. In order for a region to qualify for the tax break under the proposed rules, it must meet fulfill certain criteria around income and job availability.

The OMB has held several meetings with industry groups—Federal Advocates Inc., Ernst & Young LLP, and law firm Skadden, Arps, Slate, Meagher & Flom—according to the OMB website. One meeting included discussion of allowing areas with zero population to qualify for the tax break. Doing so would enable municipalities to invest in transforming remote areas with no residents into job-generating areas—like transportation hubs or warehouse locations.

But lack of clarity about how to deploy opportunity funds capital into opportunity zones is stunting the program, fund managers have said. Early information is important to them because the value of the program declines over time since the incentive is based on how long investments are held in designated opportunity zones.

Money invested must be deployed through a qualified opportunity fund (QOF), which can enjoy tax benefits in three ways:

  • Capital gains recycled into a qualified zone are deferred until the sale of the fund or until Dec. 31, 2026.
  • The initially invested amount of capital gains exposed to tax is reduced by 10 percent if the investment is held for 5 years and an additional 5 percent if the investment is held for 7 years.
  • The gains earned by the QOF are exempt from capital gains tax if the investment is held in the fund for more than 10 years.

Fund managers are facing a “running clock” to gain the most benefit, Scuyler Kurlbaum, founder of Kansas City-based tax planning firm Kurlbaum Rinne Law Firm, LLC, told Bloomberg Tax.

“We’re already moving against these deadlines since we’re so close to the end of 2018, and in order to benefit from the seven year deferral an investment needs to be made in 2019,” he said.