Tucked into the tax reforms adopted by Congress in late 20117 is a provision that could help funnel significant amounts of money for developments and businesses into some distressed areas of town for patient investors.
Formally known as the Investing in Opportunity Act, the new tax law offers a powerful incentive for those realizing capital gains to defer and limit the taxes normally due on such income if it is invested in designated Opportunity Zones and held in that investment for a number of years. Although critics fear it could simply give tax breaks to wealthy investors for projects that would otherwise already been done, urban advocates who pushed the idea through Congress contend it could help transform low-income communities with a private-sector approach to jobs and investment.
Bruce Katz, an urban development expert at the Brookings Institute who has touted Chattanooga's innovation district and is a supporter of the Opportunity Zones, said the open-ended nature of the investment credit gives investors far more options than the usually more prescriptive tax breaks offered for targeted investments such as those in historic buildings or solar energy projects.
"Given the significant interest among many private investors, it is possible that Opportunity Funds will attract tens of billions of dollars in private capital, making this one of the largest economic development programs in U.S. history," Katz says.
Within 8,700 "Opportunity Zones" certified this year across the country, including 176 zones in Tennessee, capital gains invested in the designated areas will be exempt from being taxed through the end of 2026, or when any investment is sold, whichever comes first. Any gains from the fund are permanently shielded from taxes if the investment is held for 10 years. In addition, the initial investment will be discounted by up to 15 percent for tax purposes after seven years.
The tax breaks are designed to encourage multifamily housing, industrial development, brownfield redevelopment, retail development and a variety of other business and building projects in the areas selected earlier this year by the Tennessee Department of Economic and Community Development, based upon county recommendations.
Tennessee's 176 tract designations are located in 75 of the state's 95 counties, including seven census tracts in Chattanooga in Hamilton County, two tracts in Cumberland County and two in McMinn County, and one census area each in Bradley, Bledsoe, Grundy, Meigs, Polk, Sequatchie and Van Buren counties.
"We place a heavy emphasis on attracting and expanding businesses to Tennessee's low-income communities, and with the assistance of the Opportunity Zone benefit, these communities will have another advantage to grow and create more jobs and opportunities," says Bob Rolfe, commissioner of the state's Department of Economic and Community Development which has offered training sessions across the state to try to maximize the economic development spurred by the new tax breaks.
In Tennessee, the state designated many zones, including several of those in Chattanooga, based upon opportunities for development and proximity to entrepreneur centers and universities, in addition to affording opportunities for low-income housing or community initiatives.
As a result, the top-ranked zones in Hamilton County included the central business district and Innovation District, where River City Co. counts more than $1 billion of retail, housing and other commercial development has already been made or planned in the past five years.
The average poverty rate in the Opportunity Zones is 32 percent, compared with the national average of 17 percent, the Treasury Department said.
While proponents of the new tax breaks argue they will help funnel needed capital into overlooked areas and communities, critics contend the exemption from any capital gains tax represents a tax giveaway to developers of projects that would be profitable without the incentives.
"There are very few guard rails on this investment," says Jesse Van Tol, CEO of the National Community Reinvestment Coalition.
In October, the U.S. Department of Treasury issued proposed rules to govern investments in the Opportunity Zones and Treasury Secretary Steven Mnuchin said he expects as much as $100 billion in private capital could be funneled into those areas.
"This incentive will foster economic revitalization and promote sustainable economic growth, which was a major goal of the Tax Cuts and Jobs Act," Mnuchin said last year.
How will it work?
Attorneys Andy Leffler and Kirby Yost with the Chambliss law firm said the capital gains must be reinvested in a qualified opportunity fund within 180 days of the sale. Anyone may set up a qualified opportunity fund, which must be structured as a corporation, partnership or limited liability company, and they must self-certify to the IRS .
To qualify, an opportunity fund must invest at least 90 percent of its assets in qualified opportunity zone property. The property can be stock or partnership interests in businesses where most of the income is from activity within the zone, or it can be real or personal property put to use or improved as a business within the zone. The assets must have been acquired after Dec. 31, 2017.
The incentive works this way: An investor might buys stock or a piece of property for $10,000 and later sells it for $15,000 gets a $5,000 capital gain. If that $5,000 gain is reinvested in a Opportunity Zone project or fund, the taxes normally due on that income could be reduced or forgiven, depending on the time horizon.
The law provides three tax advantages for capital gains reinvested in an opportunity zone or fund. First, any capital gains taxes can be deferred for seven years, if the money is kept in the new investment, and the tax on the gains also is reduced by 10 percent after five years and 15 years after seven years.
"The real home run in this is that if you hold your investment in the opportunity fund for 10 years then any gain you also make from that fund is not taxed," says Tom McCormick, a CPA at LBMC in Chattanooga.
The pool of unrealized capital gains – the profits from the sale of property or stocks – is estimated at $6.1 trillion. Anthony Veerkamp says the amount of money eligible for reinvestment constitutes "either the most significant federal community development incentive in a generation or one of the biggest tax giveaways to the rich in American history."
There is no requirement that a fund invest in a zone located within its state of formation. With such cross-border private investment allowed to benefit from the program, there may be an influx of out-of-state capital to fund projects within Chattanooga zones, which include already redeveloping areas including the 140-acre downtown Innovation District and much of the riverfront area.
Investors who can participate include individuals, corporations, businesses, real estate investment trusts (REITs), and estates and trusts.