Treasury Outlines Tax Breaks for Investing in Distressed Areas
Oct. 18, 2018
WASHINGTON — The Treasury Department outlined new rules on Friday stemming from the $1.5 trillion tax overhaul last year that are aimed at giving investors confidence to pour billions of dollars into distressed economic areas across the United States.
Investment banks, venture capitalists and real estate developers have been eagerly awaiting guidance for so-called opportunity zones, a sort of domestic tax haven that was created under the Republican tax bill that President Trump signed into law in December. The zones are devised to attract capital to urban, suburban and rural areas where investment has lagged after the Great Recession — like broad sections of Detroit and Stockton, Calif. — by allowing investors to avoid some taxes when they fund projects there.
Treasury officials said on Friday that the criteria would allow a wide variety of projects to qualify for the preferential tax treatment, including seed capital for start-up businesses in areas identified as opportunity zones.
A looming question since the tax bill’s passage has been what type of investments would qualify for the preferential tax treatment conveyed by investing in an opportunity zone. An investor who rolls capital gains into an opportunity fund can eventually avoid up to 15 percent of the taxes otherwise owed on those investment gains. And the investor will never pay taxes on any gains the fund accrues in its investments in the opportunity zones, provided that the investment is held longer than 10 years.
Proponents of the program have said the right type of structure could help drive money into distressed communities, generating economic growth and jobs. But critics have warned that the details could simply hasten gentrification of areas that were already attractive places to invest and serve as a tax shelter for wealthy investors.
Several lawyers and investment managers who reviewed the proposed regulation on Friday said it was likely to encourage a wide range of investments. “In almost all instances, these rules clarify ambiguities in a manner that makes operation of the program easier and expands availability of the benefits,” said Lisa M. Starczewski, the co-chairwoman of the Opportunity Zones Team at Buchanan, Ingersoll & Rooney.
The draft regulation reassures investors that they will still qualify for long-term tax benefits even if they invest in an area that loses its opportunity zone status in future years. It gives them 30 months to begin improving any property they buy in a zone, a cushion that real estate developers were hoping for.
“We see this as a positive sign for the success of the program over all, creating a structure that is both flexible enough to allow for businesses to thrive while also putting the right incentives in place to ensure that new capital flowing into these areas is actually put to work improving neighborhoods and creating jobs,” said Ben Miller, the chief executive of Fundrise, a real estate investment group based in Washington that is raising a $500 million opportunity fund.
The draft regulations, which will be subject to 60 days of public comment and most likely completed next spring, would allow individuals, corporations and other types of businesses to invest in new opportunity funds. The funds could only be seeded by capital gains, such as the proceeds from selling a home or a share of stock at a profit. Ninety percent of a fund’s investments must be in qualified opportunity zones.
A business counts as being in an opportunity zone if 70 percent of its tangible property is there, the regulation says. In some cases, that can lead to a fund holding only 63 percent of its assets inside an opportunity zone. But Treasury officials called it a “pretty favorable standard” for businesses. The exact percentage had been a point of contention in the Trump administration, as officials clashed in recent weeks over how flexible to make the regulation.
Governors designated eligible census tracts as opportunity zones earlier this year, choosing from a list of areas in their states that met the law’s criteria for investment starvation, and Treasury has approved those designations. Many investment banks and real estate developers have already begun to invest in those designated communities, betting that the projects they have chosen will qualify under the coming regulations.
The zones were an unheralded part of the tax law. But they have since attracted widespread interest. Civic and state leaders have drawn up plans to maximize their potential. Law firms have formed new practices devoted to navigated the regulations governing them. Investors from Silicon Valley to Wall Street have begun to raise funds devoted to projects in the zones.
“We have conversations about opportunity zones every single day” with people who want to invest or raise their own funds, said Margaret Chinwe Anadu, the head of the Urban Investment Group at Goldman Sachs, which has already made investments this year in zones in Queens, Brooklyn and East Orange, N.J. “This has become a significant amount of how we think about our economic development work.”
Steven Mnuchin, the Treasury secretary, said in recent weeks that he expected the zones to attract $100 billion in investment and indicated in a news release on Friday that he wanted “all Americans to experience the dynamic opportunities being generated by President Trump’s economic policies.”
How much the provisions costs taxpayers, in terms of foregone federal revenue, depends on how much money is invested and held in the zones. The congressional Joint Committee on Taxation predicted the provision would reduce tax revenue by $1.6 billion over 10 years, which implies a modest amount of investment. Mr. Mnuchin’s prediction, if true, would yield a substantially higher revenue loss.
SOURCE: The New York Times