The Opportunities With Opportunity Zones

March 14th, 2019

The impetus behind Opportunity Zones was established years ago, when serial tech entrepreneur Sean Parker—founder of Napster and the first Facebook president—had an idea for incentivizing investors to parlay some of their cash into distressed communities in exchange for tax breaks. Parker’s vision resonated with capitalists, philanthropists and government leaders around the U.S. As part of the Tax Cuts and Jobs Act passed in late 2017, Opportunity Zones were added to the tax code.

Opportunity Zone projects have the potential to reinvigorate underinvested communities throughout the nation, including in Northeast Ohio. And while attractive from a tax savings standpoint, investors should also be contemplative about a deal’s long-term impact, says Terry Coyne, vice chairman of Newmark Knight Frank.

“It’s a beneficial economic development tool, and it does have a sunset, so there is a lot of hype,” he said.

Crain Content Studio—Cleveland asks Coyne to shed light on how financiers can leverage Opportunity Zone investments within their real estate development portfolios.

What are Opportunity Zones, and how are they different from other tax credit incentives?

Opportunity Zones are census tracts that have been federally designated as economically distressed communities. They are areas where opportunity fund corporations or partnerships can be set up to invest in qualified properties or land that lies within those designated zones. This program allows these investor entities to either defer, reduce or never pay capital gains if certain requirements are met. This program is different from other tax incentives, such as a 1031 exchange. That mechanism requires a like-kind tangible property exchange. No improvement or use requirement is imposed, and capital gains are deferred. They eventually have to be paid upon the sale of the replacement property, unless further deferred in another like-kind exchange.

How can Opportunity Zones bolster economic development in higher-poverty census tracts?

Since the goal of Opportunity Zones is to improve and encourage development in these qualified tracts, the prevailing hope is that those areas will benefit from job creation from new, reinvigorated and expanded businesses, neighborhood beautification and additional investment in the immediate neighborhoods that the Opportunity Zone projects will anchor. Essentially, without the Opportunity Zone program incentives, private investments in distressed neighborhoods would not generate the returns needed to justify these projects. With these incentives, investments in these areas would now become competitive, thereby leveling the playing field.

What are some of the financial benefits of Opportunity Zones from an investor’s perspective? What are some of the challenges?

The primary financial benefit is to defer or never pay capital gains taxes. One secondary benefit is eliminating the capital gains tax due upon the eventual sale of the property, as long as it is held for 10 years. The challenges involved in Opportunity Zones include the uncertainty of the regulations, some of which haven’t been finalized or fully explained yet; the risks involved in investing in impoverished and low-income neighborhoods; finding investors; and securing financing.

How does a company or organization form an opportunity fund?

The process may be easier than you think. Any individual or corporation can self-certify through the IRS by filling out Form 8996 with their federal income tax return. Forming the opportunity fund is the easy part, but ensuring that all of the rules and regulations are met to get the tax breaks requires much more diligence and research.

Investment can be risky in certain zones, where, despite the tax breaks, some properties don’t stand to realize substantial gains in appreciation. So, why invest?

Even if you are not expecting property value appreciation from this type of investment, it is still a large benefit to defer capital gains from a previous investment. Another reason to invest is to be a catalyst in reinvigorating neighborhoods and areas that historically have been largely ignored.

What has to happen for meaningful appreciation to occur in higher-risk zone property investments?

The economic development departments of local communities should get in front of (and some have already) these opportunities by having a good plan to bring clustered investment to their tracts, rather than risk investors being scattered. Focused investment and strategic partnerships are necessary for meaningful appreciation to occur.

Where are some of the most attractive and potentially lucrative zones in Northeast Ohio? Which zones show potential for broader economic growth?

The great thing about Cleveland is that pretty much our entire downtown falls within an Opportunity Zone. Most of the Opportunity Zones in different parts of the country are not in central business districts like Cleveland. In addition, look to zones that are strategically located on the cusp of established neighborhoods, such as just outside of University Circle, Tremont and Ohio City. Also, suburban tracts that are well-located and with established amenities, such as Warrensville Heights and Bedford Heights, could be advantageous for potential industrial projects.