The topic of Opportunity Zones is hot, hot, hot — and for good reason. The program is shiny and new, aims to bring prosperity to areas in need and creates significant tax benefits for investors. Lawmakers are touting this opportunity as the most significant tax reform in decades and predict that billions will be invested through the program.
Communities are excited for the improvements and benefits for the residents. Investors perk up hearing they can defer or avoid capital gains tax in a number of ways. So why is it a case of more talk and less investment at this time?
Rules still changing
Considering that the legislation has not been finalized, this hesitance is certainly understandable. The OZ program is a federal program that offers investors tax benefits to purchase and improve real estate or businesses in low-income communities.
The legislation was outlined within just five pages of the 185-page Tax Cuts and Jobs Act of 2017 passed by Congress and signed by the president in December 2017. The OZ parcels, or Census tracts, were chosen by the individual states and approved in spring 2018. Nevertheless, the Treasury Department is still gathering feedback and drafting the final wording, which many expect to be out in early summer. While that doesn’t mean you have to wait to invest, it adds uncertainty, so many investors have been hesitant to jump in.
Program is confusing
While the general intent of the program makes sense, implementing it leaves much up for interpretation. For instance, for real estate investment, an investor must significantly improve the property within 31 months. Initially, that was interpreted as a requirement to double the initial investment with improvements. Now, the stipulation is interpreted as doubling only the value of the improvement — the building on the property minus the land value. If that is the case, what is the calculation for required improvement if vacant land is purchased. Zero? For investment in OZ businesses, what happens if the business outgrows its space and moves out of the OZ? It is hoped that much of the confusion will clear up with the final wording from the IRS.
Shallow pool of investors and investments
There are a number of limiting factors that rule out the masses. In order to qualify, property must to be in specific qualified OZs. Investors need to have a fairly significant initial gain in order to offset the costs. Bringing in additional investors or selling stocks can get expensive or jeopardize a participant’s ability to qualify for the tax benefits. Investments must be held for a long time, over 10 years, to reap the most benefit. Since most OZs are in areas that have struggled, there is elevated risk associated with the investment. Since perhaps the greatest tax benefit is avoiding tax on the gain from appreciation, investors want to be confident that the property will increase in value.
Sure, there are OZ deals taking place, many that were redevelopment projects that were in the works before the program was introduced. Those investments just got sweeter with the OZ tax benefits. However, until the IRS finalizes the legislation and until the new rules are better understood, don’t be surprised to see investors remain tentative.
Gerry Schauer is a vice-president in Avison Young’s Charleston office. He specializes in office and investment real estate leasing and sales. Contact him at firstname.lastname@example.org or by phone at 843-973-8351.