Now Is A Good Time To Invest In Distressed Communities Across America
Through the Tax Cuts and Jobs Act of 2017, the U.S. government will be offering taxpayers certain incentives designed to encourage long-term investments in distressed communities and government partitioned low-income areas across the country. These areas, called Opportunity Zones, are designated by the governor of each state and could literally be right in your surrounding area or next door to where you live.
If done correctly, investments in Opportunity Zones have the potential to pull millions of Americans out of poverty and generate both financial and social returns for investors.
The 2017 Distressed Community Index (DCI) reports that 52.3 million Americans currently live in economically distressed communities with more than a quarter of those residents at or below poverty levels. This means that one in six Americans could have a chance at a better life that ultimately benefits future generations. Sounds good, right?
So how do these incentives work? According to a press release issued by the U.S. Department of the Treasury and the Internal Revenue Service (IRS), investors can defer tax on prior capital gains up until December 31, 2026 – as long as those gains are reinvested into Qualified Opportunity Zones. These investments are pooled into certified investment vehicles called Opportunity Zone Funds, which are required to have at least 90% of their assets invested in these zones.
If an investor holds the O-Zone investment for five to seven or more years, they will benefit from an improved “stepped up basis” — as much as 15% for investments held for seven-plus years. Should an investor hold their stake in said fund for 10-plus years, they would then benefit from not only the 15% step-up in basis but also from a permanent exclusion of all gains accrued after investing in the O-Fund. This is a significant incentive that should prove to be transformative for these communities and lucrative for investors.
Opportunity Zones are determined by the states and approved by the government. However, governors are limited in their selections and can only name 25% of their state’s low-income areas as Opportunity Zones, which then hold the designation for 10 years. As of June 14, 2018, submissions have been approved for all 50 states, the District of Columbia and five U.S. possessions. To view all Qualified Opportunity Zones, click here.
To become a Qualified Opportunity Zone Fund, the IRS states that an eligible taxpayer must simply self-certify by completing a form (set to be released in the summer of 2018) and attaching the form to their federal income tax return for the taxable year. Through this process, no further action or approval is required by the IRS, which makes the process relatively easy and straightforward. However, this also means that very few guardrails are in place for these fund managers aside from applying the proper hold period and investing at least 90% of the Fund’s holdings within the designated Opportunity Zone boundaries. This makes it especially important that investors vet fund managers to ensure their investment capital is being properly deployed.
While they’re only a hypothesis for now, Opportunity Zone Funds seem to have the components necessary to maximize financial, social and environmental returns that investors desire and require, and are ultimately beneficial for communities. Tax breaks used to incentivize investment into these historically depressed neighborhoods have the potential to transform and reposition communities throughout the nation. Post-investment results for residents such as a higher quality of life, fueled by economic diversity and activity, enhanced by infrastructure and improved housing supply, more job opportunities that collectively help raise their standard of living. Who wouldn’t want that?
Some postulate that investment in these areas could come at a significant cost to those living in these communities, and it usually does. Investment opportunities in low-cost areas tend to entice and attract even more investment in said areas, which then increases the demand for and cost of housing in these zones. When job growth and income levels fail to keep up with rising costs, lower-earning individuals and families are by default pushed out of their neighborhoods in search of cheaper lands, effectively negating potential social benefits. This is an ironic result, to say the least.
What many in the affordable housing space are currently pondering is, “How do we reduce this risk?” Given the loose guardrails of the current statutory legislation as it’s written, it will be challenging for the government to regulate the types of investment projects that will ultimately operate in these regions. It is my opinion that the onus to do so will eventually fall on developers and investors themselves, to ensure that their investor dollars work to improve area conditions for existing residents — not to replace them entirely with wealthier ones. Immediate investments from socially conscious impact investors and impact corporations who have a history of socially responsible investing and are concerned with preserving the integrity, well-being and longevity of these areas, are necessary to establish a precedent, or guardrails,for future development.
Ultimately, the progress of these low-income regions rests upon not only the action of the investment community at large, but also and more importantly, on the fiduciaries, the stewards of capital, the future Opportunity Zone fund managers themselves who are gearing up to deploy investment into these regions. Having spent the majority of my real estate investing career on the ground, fighting for improved housing and higher standards of living for lower-income Americans, it’s only natural that I look forward to taking on this challenge.