Opportunity Zones Knock
By Timothy McCausland, Managing Director, Private Banking, with Orange Bank
and Trust Company
Slowly but surely, the term “Opportunity Zone” is making its way into the lexicon of economic development professionals, municipal leaders, bankers and developers. The Opportunity Zone community development program is a federal plan enacted into law through the Tax Cuts and Job Acts of 2017. The program encourages private investment in low-income urban and rural communities.
The wheels that support and propel Opportunity Zones, or “OZs”, are the tax savings investors will enjoy by investing in OZs and, the longer an investor keeps his or her investment in OZs, or Opportunity Zone Funds, the greater the tax savings. By providing possibly significant tax savings in the right circumstances, the new law will, in theory, attract private investment into low income neighborhoods. For efficiency, diversification and greater deployment, it is widely believed that most of the funding into OZs will come from Opportunity Zone funds.
Like any economic development plan that encourages private investment, projects still must make sense on their own merits, notwithstanding the tax incentive. Only in rare circumstances does a tax break turn a bad project into a good project. From a development perspective, the designation of OZs across the state and nation will draw focus on communities that, frankly, need more focus and, if viable projects can be devised and funded, those communities will benefit. The designated OZs were chosen based on recommendations from New York State’s economic development professionals, local input, prior public investment and a presumed ability to attract private investment.
Commercial lenders will likely play a large role in the deployment of Opportunity Zone funding since project financing will look and feel the same as any other development project. While there are paperwork, tax return and other administrative tasks required to participate in OZs, it is all about the geography regarding qualification.
The details of the tax incentive for OZs are fairly straightforward. Investors must invest in a qualified opportunity fund (or project) which holds at least 90% of its assets in qualified opportunity zone property. A “qualified opportunity fund” is an investment vehicle organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property.
For New York State residents, there are three incentives to encourage investment in qualified opportunity funds. First, investors can temporarily defer the inclusion in gross income of capital gains that are reinvested in a qualified opportunity fund. Secondly, investors can permanently exclude capital gains from the sale or exchange of an investment in a qualified opportunity fund held for more than ten (10) years. Finally, both the deferral and exclusion of the capital gains from federal income will flow through to New York State, meaning those gains will also be deferred and excluded from New York taxable income.
It may take a few passes through the details of this new legislation to realize the impact, but the tax savings could be huge for those willing to take current gains, invest those gains and hold their investments for ten years or more. Yes, the leap of faith is that the investment in an Opportunity Zone will “hold” and appreciate, but the carrot of a permanent exclusion will probably be very attractive for developers and other investors.
Tim McCausland is the Managing Director of Private Banking at Orange Bank & Trust Company.
*Information obtained from New York State Economic Development Corporation Opportunity Zone “FAQ” page - https://esd.ny.gov/opportunity-zones