By Valerie Grunduski
Five years after Congress created the Opportunity Zone (OZ) program as a way to channel investment dollars into needy areas, Congress is set to amend the program so that it functions more in line with its original intent.
This could be great news for current and potential investors, especially those who care about the positive effect their ventures have on society. But before discussing why investors should care, it’s important to understand the two major shortcomings that precipitated the coming changes.
The first is mostly bureaucratic. The opportunity zone program got off to a slow start, partly due to delays in Treasury guidance. Now, the current 2026 deadline for investors to defer capital gains taxes is fast approaching, leaving them with a shrinking incentive to participate.
The second problem is more fundamental: Due to a lack of reporting requirements in the original statute, there is not enough data available to measure the impact of the program on objectives such as job creation and business growth in low-income areas. A report by the Urban Institute found that most of the money invested through the program has been channeled to real estate projects rather than the smaller businesses it was aimed at supporting. Because the nearly 9,000 OZs selected under the program were based on 2010 Census data, some of the areas had already become more economically vibrant by 2020 but still received investment.
A New and Improved Plan
The good news is that the OZ program is set to get a second lease on life. A group of senators introduced a bill in April that would make significant changes to the program and has a good chance of winning approval given solid bipartisan support on the issue.
The key proposed reforms are:
- Extending the deadline for capital gains tax deferral by two years to 2028
- Imposing more detailed reporting requirements on Qualified Opportunity Funds (the entities that absorb OZ investment) to improve transparency and impact
- Allowing tiered structures so that those funds can invest in other funds within the program
- Sunsetting some OZs and allowing states to replace them with tracts in higher-need communities
What Does All This Signify for Investors?
The two-year extension of the capital gains tax deferral is an obvious improvement in incentives: It will make the funds more attractive by expanding the amount of time potential investors have to make a qualified investment. Additionally, by deferring their tax payment to 2028, investors may still be able to qualify for the partial increase in basis that expired in 2019 and would reduce their tax liability. They’re also still eligible to pay zero capital gains tax on any profit on the investment when they sell it after a 10-year hold period and can benefit further from depreciation along the way.
The move to sharpen the program’s focus on its goal of benefiting low-income areas also has implications for investors. The bill requires funds to file an annual report with more detailed information than previously required, including how investments are impacting business development and job creation.
This means that funds might have to work harder and may need to hire people or engage additional service providers to meet the reporting requirements. The stricter compliance rules could turn off some investors who had been viewing the program solely through a lens of maximizing profits and tax avoidance. On the other hand, it will make OZs more attractive for the growing ranks of investors who want to have a social impact and who had perhaps remained on the sidelines until now.
What About ESG?
The tougher requirements and greater focus on social impact could also make it easier for investments in OZs to be classified as ESG-compliant. Investors will be able to question funds on how they are meeting the new criteria and ask for data to back it up.
The allowance of a tiered funding structure should expand the opportunities for investment for bigger players. Under the previous structure, it may not have made sense for a large institutional investor to support a relatively small project. A tiered fund would allow them to spread a larger dollar amount out over several smaller projects.
The designation of new OZs under the law will also create opportunities. Investors may even reach out to state authorities to encourage the inclusion of deserving areas that have growth potential. At the same time, previously neglected OZs may become more attractive targets for investment under the new standards.
Investors should also keep a close eye on additional financial incentives states may provide to supplement the federal program, which several states, such as Ohio, have already done under the existing OZ initiative. At the other end of the spectrum, California does not allow federal incentives to be applied to state taxes.
Overall, the new bill is a welcome update that has the potential to reinvigorate the OZ program, creating better alignment with its social goals while still providing attractive tax savings and growth potential for investors.
About the Author: Valerie Grunduski
As a real estate tax specialist at Plante Moran, Valerie Grunduski advises clients on planning concerns related to purchases and sales, partner buy-outs and redemptions, tax and debt structuring, historic tax credits, and other community development incentives. In addition, she consults with clients on how to best utilize the opportunity zone incentive. As the firm leader of this investment vehicle, Valerie works with those seeking to create opportunity zone funds and is involved in a coalition to help policymakers shape regulations and legislative corrections. To learn more, visit plantemoran.com.
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