As part of the 2017 Tax Cuts and Jobs Act (TCJA), the Opportunity Zone incentive was established to attract large amounts of capital to low-income neighborhoods and contiguous communities in hopes that they would be revitalized. Yet congressional leaders rushed the passage of the TCJA; the new tax law provides the bulk of its benefits to the wealthy and corporations, and the Opportunity Zone incentive is no exception. While its proponents claim that it will provide benefits to struggling communities, the only certainty is that it will provide excessive tax breaks to investors. Congress and the Department of the Treasury could have mitigated this by including guardrails in the legislative language or the implementing Opportunity Zone guidelines, in order to ensure that struggling communities will actually benefit, rather than simply be displaced. But with the release today of the first Treasury guidelines under the new program, this has not happened.
What are Opportunity Zones?
Opportunity Zones were created to infuse capital, in the form of unrealized capital gains, into the communities most in need of it. The hope is that this infusion of capital will bring jobs and a higher standard of living for Opportunity Zone residents. It has been argued that up to $6 trillion will be available to invest in eligible neighborhoods. Investors can receive a tax deferral and other tax benefits if they roll over capital gains from their investments into an Opportunity Fund. If investors hold the investment in an Opportunity Zone for at least five years, their basis in their original investment is stepped up by 10 percent, reducing the amount of taxable gain they will ultimately have; if they hold it for seven years, their basis is stepped up by an additional 5 percent. The tax on the original amount invested is deferred until December 2026—or earlier, depending on if and when it is sold. Plus, any new capital gains from the Opportunity Zone investment go untaxed if the investor holds their interest for at least 10 years.
The eligibility of census tracts is based off either their federal poverty level or statewide or metropolitan area median income. Tracts with poverty rates above 20 percent or that have below 80 percent of the area median income are eligible for Opportunity Zone investments.
Opportunity Zone guidelines lack necessary guardrails
The guidelines released today provide details on how investors can qualify for deferral of gains, what constitutes a Qualified Opportunity Fund (QOF), and how to treat tangible business property in an Opportunity Zone. The key regulations stated are:
- A QOF must hold at least 90 percent of its assets in a qualified Opportunity Zone property, but it can hold working capital for a period not longer than 31 months. This “safe harbor” provides a sufficient amount of time for investors to make decisions about how to invest in the Opportunity Zone.
- The threshold for the term “substantially all” when referring to how much of the funds in a QOF need to be invested in a qualified Opportunity Zone business property is 70 percent, as measured by the amount of tangible property owned or leased in the zone.
The rules released today are not the final rules governing the incentive program but are available to provide clarity so that investors can begin the planning process for partaking in the program. The guidance provided today is only the first set of guidelines for the incentive program, and there will be further guidance provided at a future time.
The guidance provided for the Opportunity Zone incentive program says nothing about how these investments can be employed. These guidelines lack the necessary guardrails to ensure that the funds eligible for use in Opportunity Zones will actually go toward individuals currently working and residing in designated low-income communities and other contiguous communities.
The problem with the Opportunity Zone incentive, as enacted in the TCJA, is that it may only tangentially affect the people it is supposed to help, while providing unnecessarily large tax breaks to investors. Those tax benefits are likely to cost much more for taxpayers than originally estimated, resulting in an even greater loss of tax dollars for the average taxpayer. At the very least, Congress and the Treasury Department should have established rules ensuring that the money will be targeted at the communities—and the people in them—who are supposed to benefit.
While the Opportunity Zone incentive may increase real estate development in certain geographic areas, there are no guarantees that existing residents will not be displaced in favor of luxury condominiums. There are many ways that the rules governing Opportunity Zones could have protected local residents; for example, they could have offered subsidized mortgages to low-income residents or required housing development projects to designate a portion of living spaces for low-income residents. The Treasury Department’s rules also allow tax-subsidized Opportunity Zone investments to include a large portion of investment—up to 30 percent—that is located outside the zones.
Certifications for Community Development Entities (CDEs) provide a model of what effective guidelines could look like. These certifications include a primary mission test and an accountability test. A primary mission test states that the entity is providing capital for low-income communities or low-income individuals. An accountability test states that any governing board has community representatives. These kinds of tests help ensure that investment capital does not lead to rising gentrification, where local residents get priced out of their homes. An Urban Institute study shows that 4 percent of designated tracts have gentrified before the Opportunity Zone program has even begun. And many more tracts are at risk of gentrification. Today’s Treasury regulations could have ensured that Opportunity Zone funds would not exacerbate this process.
How to ensure that Opportunity Zone funds revitalize distressed communities
Business investment should be focused on investing in existing firms in Opportunity Zones or in firms that hire local residents. There are resources available on how to build and promote such equitable development. PolicyLink provides a guide for Opportunity Zone investors and developers, foundations, and local governments. The Treasury Department could suggest guidelines that ensure that benefits accrue to community residents by incorporating some of PolicyLink’s recommendations, such as requiring investors to submit their investment intentions to a local nonprofit authority. These intentions should include commitments to social returns on investment, equitable growth, and development without resident displacement.
Guidelines should also explicitly define abuse of the program in order to curb any negative behavior from property developers. Having reporting requirements can ensure that there is transparency regarding who is setting up these funds, the amount of money being funneled into these funds, and where the funds are being invested. An important feature highlighted in the PolicyLink recommendations is performance metrics. Incorporating these metrics would allow local government or an oversight body to assess how well the Opportunity Zone incentive is meeting its stated objectives, including the creation of living wage jobs, investments in businesses owned by underrepresented groups, and the creation and preservation of affordable housing units. These metrics can be used by a relevant oversight authority to properly assess whether Opportunity Zone funds are truly revitalizing distressed communities.
Conclusion
To be sure, the fault with respect to the above concerns lies primarily with Congress. Concerns about displacement and gentrification have been evident throughout discussions about Opportunity Zones. To meet the stated objectives of the Opportunity Zone incentive, the Treasury Department needs to provide strong, effective certification guidelines. Unfortunately, the guidelines announced today fall short. The Center for American Progress hopes that when further guidance is issued, it will address these shortcomings. It is incumbent on state and local governments, along with local institutions, to provide the structure necessary to enable residents in these distressed zones to be involved with processes designating the receipt of new capital, as well as included in any resulting benefits.
Olugbenga Ajilore is a senior economist at the Center for American Progress.