Sen. Tim Scott (R-SC) and Sean Parker tour the senator’s childhood neighborhood as an example of the areas that can see investment through the opportunity zone program.
Evan Kafka for Forbes
President-elect Joe Biden and his administration are keen to undo much of what their predecessors did. Yet when it comes to one flagging Trump initiative— the opportunity zone program— Biden and the Democrat-controlled Congress could actually provide a big boost.
The unique program, which offers a complicated and multipart capital gains tax breaks on funds invested into certain lower income zip codes (as identified by local officials and blessed by the Treasury) was created by the Tax Cuts and Jobs Act of 2017 (a.k.a the Trump tax cuts), which passed without any Democratic support. Yet the opportunity zone idea has bipartisan roots.
That crucial cross-aisle appeal, combined with the potential for increased regulatory clarity, possible tax rate increases, the massive gains of the unprecedented bull market of the last decade-plus and the economic devastation in cities from Covid-19 have all set the stage for what could be a long-anticipated rush to opportunity zones.
The structure of the program provided the biggest tax breaks to those who invested by 2019. But regulations were slow to come out and investors shied away. Another deadline to reap bigger benefits comes at the end of 2021. Here’s why: There are three parts to this tax break. The biggest and longest lasting break is that you pay no tax on capital gains realized in an opportunity zone fund, provided you hold the fund investment for at least 10 years. The second part is you can roll over gains from other investments into an opportunity zone and defer paying taxes on the rolled over gains until the end of 2026. The third part of the break is that the basis in your rolled over gain, when it’s taxed in 2026, is increased by 10% if you’ve been in the opportunity zone fund for five years, or by 15% if you’ve been in the fund for at least seven years——which is where the deadlines of 2019 and 2021 come in.
Despite President Trump’s repeated insistence on taking credit, the idea for opportunity zones goes back to 2007 and tech billionaire Sean Parker, who spoke with Forbes about the program in 2018. It was championed by Senators Tim Scott (R-SC) and Cory Booker (D-NJ). The program’s broad appeal isn’t hard to understand: Democrats like the program’s potential to draw investment to poor neighborhoods and Republicans are on board because it’s built on tax breaks and private enterprise. In theory, opportunity zone investments should appeal to both those looking to reduce their tax liabilities and the growing numbers of social impact-minded investors.
But from the start, the program—as created and administered under Trump— drew criticism for being poorly targeted, with already gentrifying neighborhoods qualifying as opportunity zones and the original legislation containing no requirements that those in the zones actually benefit from the jobs created. There wasn’t even a requirement for a follow up study of the program’s effectiveness.
The current lax regulations require a simple self certification and documentation of the census tract in which the investment is being made. The Government Accountability Office has highlighted the shortcomings of the program, calling for increased oversight.
Indeed, Biden was vocal on the campaign trail about looking to rein in the program. But he’s also signaled support for the program, including bringing into his administration members of the previous two administrations who were some of the original architects of the program. In other words, the potential exists for a more regulated, targeted and monitored version of opportunity zones to take off—particularly in a climate of rising tax rates and cities ravaged by Covid-19.
Abandoned rowhouses in Baltimore City, the type of areas that the program looks to target.
Kevin B. Moore/Getty Images
Nicholas Parrish, a managing director of Cresset Partners, which has sponsored opportunity zones funds, says the lackluster early adoption of opportunity zones is partly the result of a rollout that left much to be desired. Delayed clarifications of the regulations and a lack of metric requirements for impact were among the issues that took too long to resolve or still remain outstanding.
A report by the Urban Institute found that the program was not living up to its goals in economic and community development. Additionally, there has been aggressive reporting by the media on how the program is being taken advantage of, including by the two of the richest men in the world. Both Jeff Bezos and Elon Musk have sites that are part of their space programs, reaping the tax benefits to increase their massive riches while having investments that have dubious benefits to the surrounding communities, as reported by Bloomberg.
An article in The New York Times in August of 2019 highlighted the fact that much of the tax break was going to the wealthy and connected and to projects not expected to provide meaningful benefits, with much of the development having been underway before the tax bill created the tax break.
“Capital is going to flow to the lowest-risk, highest-return environment,” an official from the Kresge Foundation, a community-development group in Troy, Mich. told the Times. “Perhaps 95% of this is doing no good for people we care about.”
To add to opportunity zones’ image problems, Forbes and others reported how Trump’s daughter Ivanka and son-in-law, Jared Kushner, stood to benefit from the tax break, which Ivanka had championed.
Trying to ensure that opportunity zone projects meet any metrics the Biden administration comes up with for impact and also provide value as an investment will require outside the box thinking on what can be beneficial to underserved communities, Parrish says. He points to a high rise building his firm is putting up in downtown Houston. It is admittedly far from the most economically distressed of locations, but he argues that the project will bring more residents downtown after Covid-19 emptied out offices, hurting central business districts. In his view, this will not only benefit the residents of luxury apartments but bring jobs for those involved in construction as well as restaurants and services to cater to the new residents.
In order to maintain bipartisan support in the longer term, investments will likely have to prove they are making an impact. In cities such as Chicago, where then-Mayor Rham Emanuel made the city’s most economically depressed neighborhoods opportunity zones, there has been little to no investment out of fear that there aren’t profits to be made. The program, especially from the standpoint of Democrats, will have to have meaningful impact in distressed areas to justify the sweet deal on taxes.
“You have to strike that balance to find areas in the zones where you can have an impact but where you can also make good investments,” Parrish says, “Having provisions that require ten years of investment helps because you can find those assets that are maybe on the fringe today but over a long period of time with patient capital can draw development.”
A similar program, 1031 exchanges, could be on its way out under President Biden, even further pushing more funds into the opportunity zone coffers as these two tax strategies were already seen as alternatives to one another.
The stage is set for 2021 to be the year opportunity zones reach their hyped potential amidst the support of disparate figures from Obama and Booker to Trump and Scott to Parker. With the election finally and mercifully in the rearview mirror, Parrish and his colleagues at Cresset have already started hearing back from some contacts they spoke with in the summer and are seeing renewed interest in investing.
Still outstanding is the question of whether new census data will be applied in order to ensure that investors have to aid truly hurting neighborhoods rather than investing in already gentrified ones. However, Parrish points out that that would likely not be retroactive and take until 2022 to be implemented.
For now, Cresset pushes forward with its second fund after Fund I invested in a portfolio of developments worth over $1.2 billion. Fund II already has projects worth over $1 billion.