Opportunity Zone Fund
- Now that the Dec. 31, 2021, funding deadline has passed to take advantage of the 10% basis step-up provision (assuming a five-year hold), some skeptics will argue that the economics of the federal opportunity zone (OZ) program have been diminished. Not so.
- The long-term benefits of the OZ program have not changed for investors, municipalities, and disadvantaged communities alike. We encourage you to recommend OZ investing for clients who have substantial gains from the sale of appreciated tech stocks, family businesses, real estate, stock portfolios, and even cryptocurrency and collectibles — especially if those clients are cause-oriented and/or need tax strategy help. Even though the Dec. 31, 2021, deadline has passed, the OZ program still offers CPAs and their clients the opportunity to defer tax on 2021 capital gains for up to five years into the future.
- Contrary to how it is often portrayed in the media, the OZ program is not just a game the wealthy can play for tax deferral (aka “avoidance”), and it’s not just about real estate.
- As we’ll discuss shortly, the OZ program has already had a positive (and measurable) impact on job creation, home values, and entrepreneurship in many of the 8,700 nationwide census tracts designated for OZ investment. Most OZ tracts are in economically challenged areas often bypassed by traditional real estate developers, retailers, and even place-based government programs.
- Before looking closer at the investment, tax, and society-benefiting possibilities of the OZ program for your clients, let’s review the original purpose of the OZ program and look ahead to its future benefits.
- While often portrayed as a last-minute addition to the 2017 law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, the OZ program was conceived under the Obama administration and finally passed in a bipartisan fashion in late 2017. The OZ program was designed to encourage taxpayers with high concentrations of wealth in tech stocks, family businesses, real estate, stock portfolios, and alternative assets to liquidate those assets to help fund development in economically challenged areas. In return for making a long-term commitment to those areas, investors receive multiyear deferral and ultimately tax exemption on their post-reinvestment appreciation.
- That remains the case today. Regardless of what each investor’s motivation is for participating in the OZ program, it has already had a measurable positive impact in all 50 states (as well as U.S. territories).
- According to national CPA firm Novogradac, more than $20 billion in equity dollars had been invested in the OZ program as of September 2021 (“Novogradac Opportunity Fund Tracking Surpasses $20 Billion,” Novogradac website (Oct. 22, 2021)). This is a conservative figure since it generally excludes “captive” OZ funds formed by family offices and high-net-worth taxpayers. Furthermore, these projects have a “capital stack” that is generally leveraged at a 4:1 ratio or greater. So, the total project funding is easily closer to a range of $80 billion to $100 billion — already meeting the White House’s targeted funding through 2027.
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Societal Benefits
Four years into the program, federal and local authorities are formalizing their reporting about ways in which the program is impacting OZ communities, including local residents. Increases in job growth, home values, and overall economic growth in OZ tracts are being measured. Here is an example of what we’re finding:
What’s Next?
The Biden administration will undoubtedly expand annual reporting of OZ fund activities and community impact. Depending on whether the Build Back Better (BBB) bill rises from the ashes or gets restructured, we may see the OZ program combined with certain infrastructure projects to maximize leverage and encourage public-private partnerships.
While many use the OZ program in connection with real estate, firms engaged in venture capital and private equity — initially reluctant to jump into the OZ investment pool due to its 10-year time horizon — have begun taking advantage of the OZ program’s benefits to fund operating businesses in designated OZ tracts. These operating businesses — not all tech startups seeking “cheap rent” by the way — have the potential to expand job creation when combined with other tax program advantages in these areas. Meanwhile, private-equity investors are segmenting certain longer-term real estate investments into OZ structures.
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Investment and tax benefits
While many believe the window of “opportunity” to invest in the OZ program closed on Dec. 31, 2021, clients who are sitting on large capital gains generated in calendar 2021 may still be eligible for OZ reinvestment. To the extent their gains are reportable on a Schedule K-1, taxpayers have as late as Sept. 10, 2022, to reinvest. However, if the taxpayer directly held the sold assets, such as stock holdings, a plot of land, or cryptocurrency, he or she has a much stricter 179-day reinvestment period after the date of sale.
The OZ program still has two important benefits remaining from a tax perspective:
2022 OZ Investment Horizon
With the prospect of higher federal and state taxes looming on the horizon on top of inflationary pressures on the U.S. economy, there is no better time for clients to consider investing in an opportunity zone. The program will be even more appealing if certain potential tax law changes included in the recently defeated BBB bill ultimately resurface. Those changes include reducing the Sec. 1202 small business stock exemption to 50% from its current 100% level, as well as limiting Sec. 1031 transactions, raising marginal tax rates, and reducing many other deductions.
With tax rates likely to rise in the near term and with inflation boosting the dollar value of capital gains, the OZ exemption becomes even more attractive as a way to mitigate a client’s tax exposure from appreciated stocks, bonds, real estate, crypto, and NFT (nonfungible token) investing. As a result, we anticipate billions of dollars of additional gains finding their way into the OZ program in calendar 2022. Remember, under current tax rules, qualified gains can be invested into the OZ program through September 2027.
A Great Tax Incentive Program
The federal OZ program remains one of the greatest bipartisan tax incentive programs to pass Congress in decades. You and your clients do not want to ignore this powerful and flexible program while it is still in place. Understanding how the program works and which fact patterns you should watch for will add tremendous value to your client relationships as you help clients optimize their investment, tax, and social impact opportunities.
