A recent Brookings Institute Report cited an estimated 780,862 new jobs in opportunity zone tracts (Arefeva et al., “Job Growth From Opportunity Zones,” Brookings Institution (Feb. 19, 2021)). This employment growth took place across multiple industries ranging from construction to service industries. We agree with many researchers and policy watchers that OZ-induced employment will continue to flourish as more OZ businesses are established across the country.
With many investors deferring capital gains into real estate projects, housing prices have seen a higher percentage increase in OZ tracts than in comparable non-OZ tracts since the program rolled out in 2018. In other words, researchers have found a measurable, albeit modest, boost to housing prices in OZ tracts above and beyond what could be attributed to the overall spike in U.S. housing prices. Rising home values benefit areas adjacent to OZ tracts, too, by lifting the entire community and adding equity into people’s homes that was previously limited or held down by their geographic location (U.S. Department of Housing and Urban Development (press release), “New Report Shows Opportunity Zones on Track to Lift One Million Americans Out of Poverty” (Aug. 25, 2020)).
OZ business are continuing to flourish in more than just value. One OZ business, for instance, is addressing a need for housing. MIT Modular (MITmodular.com) in Provo, Utah, is transforming shipping containers into affordable housing. These units are easy to transport and can be taken to cities to provide affordable housing for seasonal workers and the homeless. (Full disclosure: One of the authors co-founded this business.) This is not the only OZ-based business seeking to benefit society. There are many others making great strides in green energy, new technologies, and countless other areas. These businesses will continue to boost community employment and community development (and civic pride) while offering investors substantial upside on their money.
There is an initial tax deferral of the original capital gains (short-term or long-term) until Dec. 31, 2026. Taxes will be payable April 15, 2027, at the rates in effect in calendar 2026. Think of this as a five-year “interest-free” loan — a valuable benefit for any taxpayer, not just real estate investors. Over the past 18 months we have seen a huge increase in crypto traders utilizing the OZ program to defer gains. Since most crypto gains are short-term, they are subject to the highest marginal rates. The benefits of deferring gains from crypto (and other alternative assets) into the OZ program can be substantially greater than reinvesting long-term gains. (See Christian, “Investors Are (Legally) Shielding Crypto Gains in Opportunity Zones,” Tax Insider (Nov. 18, 2021).)
By far the most valuable benefit remaining under the OZ program is the ability to achieve tax-exempt growth of one’s investment after a 10-year holding period. Upon selling the investment, there will be no federal tax on the investor’s proceeds. Every state other than California, Mississippi, North Carolina, Massachusetts, and New York honors the exemption. This exemption is the primary reason why people continue to invest their capital gains into the OZ program. The exemption extends to depreciation and tax credit recapture, which only adds to the total internal rate of return on an investment.
As mentioned earlier, the third key benefit of the original OZ program expired on Dec. 31, 2021. That was a tax basis increase of 10% of the fund balance after holding an OZ fund for five years. If you have clients asking about the loss of that provision, remind them that this benefit was a very small part of the OZ program. If you run the math, you’ll see that even though the Dec. 31, 2021, window has closed on basis step-up, it only brought high-net-worth investors an additional savings of 2.38% (10% × 23.8% tax rate) on long-term gains and only 4.08% (10% × 40.8% tax rate) on short-term gains. That’s a rounding error for most people, considering a 10-year investment period.