Tax incentives to invest in urban and rural low-income areas
Published March 20, 2018
This post is one in a series about the federal government’s new Opportunity Zones program, which provides tax benefits to investors who invest and hold capital gains in eligible assets in select low-income census tracts. For additional information, see our CD360 Notebook posts that provide questions about the program and demographic and economic information about Ninth District designated tracts.
The Opportunity Zones program created by the recent federal tax bill has the potential to funnel private investment capital into urban and rural low-income areas, but has also raised concerns about potential unintended consequences. This post provides a high-level overview of the new program and describes efforts by some state governors in the Ninth Federal Reserve District to designate Opportunity Zones within their states. A companion post will explore questions raised by community development practitioners about the Opportunity Zones approach.
Passed in December, the Tax Cuts and Jobs Act created Opportunity Zones and Opportunity Funds. Once they are rolled out, the two are intended to work in tandem to provide tax benefits to investors who invest and hold capital gains in eligible assets in select low-income census tracts.
In the short term, the legislation requires governors to designate Opportunity Zones among eligible census tracts within their state. Tracts are generally eligible based on having a median family income that does not exceed 80 percent of median income1 and a poverty rate of at least 20 percent. Governors may pick 25 percent of such tracts within their state. Five percent of a governor’s selection may be otherwise ineligible tracts that are contiguous with Opportunity Zone-eligible tracts and have a median income that does not exceed 125 percent of the median income of the adjacent qualified tract. The U.S. Department of the Treasury (Treasury) is responsible for certifying the tracts in governors’ proposals, and has created a map showing all eligible tracts.
For example, in Minnesota, 509 census tracts qualify as potential Opportunity Zones based on their income and poverty levels. Minnesota Governor Mark Dayton is responsible for proposing 128 tracts to receive the designation; 7 of these may be eligible based on adjacency rather than on their income level.
Designating Opportunity Zones
The law does not contain instructions for how governors must make their decisions, but does contain a March 21, 2018, deadline. Governors may apply for a 30-day extension to the deadline. Minnesota, North Dakota, and Montana have already applied for and received such an extension.
Three of the Ninth District’s states have created websites and instructions for local leaders to submit their recommended Opportunity Zone tracts. Minnesota’s four first-class cities,2 87 counties, and 11 tribal nations can submit their prioritizations by March 29. Staff from Minnesota Housing, the Minnesota Department of Employment and Economic Development, and the Minnesota Department of Revenue will use these rankings to develop the state’s final submission to Treasury.
Minnesota’s web portal features information about the Opportunity Zone program alongside tools for assessing an area’s Opportunity Zone-eligible tracts. The portal also describes the principles that will guide agency staff’s final Opportunity Zone selection process, and includes a recording of a webinar intended to answer questions about the Opportunity Zone program and process.
The deadlines for county, city, and tribal officials to complete an application to propose designating specific census tracts as Opportunity Zones in North Dakota and Montana are March 19 and March 30, respectively. The applications ask for information about the census tract, such as current or expected development, projected impact on reducing poverty, capacity to attract investment, and any barriers to development.
Meanwhile, the Wisconsin Housing and Economic Development Authority has created a web page featuring a summary of the Opportunity Zone program. According to the web page, an interagency group is developing the process and parameters for making Opportunity Zone recommendations to the governor; people with questions or comments on the Opportunity Zone program are referred to an email address. In Michigan, an Opportunity Zones web page describes the methodology and data used for tract designations. (Update: Wisconsin and Michigan submitted census tract designations by the deadline.)
Up next, Opportunity Funds
To qualify for a tax break in an Opportunity Zone, investors must channel their money through an Opportunity Fund. The Opportunity Fund structure provides a tax deferral that creates an incentive for investing unrealized capital gains. After five years, 10 percent of a deferred and reinvested capital gain is permanently excluded from taxation; after seven years, the exclusion increases to 15 percent. The tax bill for deferred capital gains comes due on December 31, 2026; thus, Opportunity Funds must be formed by the end of 2019 for investors to realize the full tax benefits. An additional benefit is available if the Opportunity Fund investment is held for ten years—any appreciation of the investment at the time of sale or exchange is tax-free.
Opportunity Funds will be certified by Treasury’s Community Development Financial Institutions Fund. Opportunity Funds must invest at least 90 percent of their assets in equity in businesses or real estate in Opportunity Zones.
What to expect?
Proponents of the Opportunity Zone program argue that it will increase the amount of capital available in low-income, distressed neighborhoods by tapping into a sliver of the more than $2 trillion in unrealized capital gains in the nation. However, skeptics have raised concerns about how the program may impact people living in Opportunity Zones, such as whether some investments could lead to displacements of residents or small businesses.
In the end, how Opportunity Zone investments play out will depend on a lot of moving parts, such as the designation of census tracts, Internal Revenue Service guidance on the certification of qualified Opportunity Funds and eligible investments in Opportunity Zones, Opportunity Funds’ response to incentives to invest in distressed communities and produce financial returns, and the role local leaders and intermediaries might play.
1 The full Internal Revenue Service description of the 80 percent threshold reads as follows: "The tract is not located within a metropolitan area and the median family income does not exceed 80 percent of the statewide median family income, or the tract is located within a metropolitan area and the median family income for such tract does not exceed 80 percent of the greater of statewide median family income or the metropolitan area median family income."
2 Minneapolis, St. Paul, Rochester, and Duluth.