4 Takeaways from Proposed Opportunity Zone Regulations

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The Opportunity Zones program, passed into law last year, went by nearly unnoticed after it was bundled into the larger 2017 tax reform bill. Many state and local leaders were first introduced to the program during the 90-day window for zone selections at the start of this year. While the first year of the program was marked by ambiguity and uncertainty, many cities remain committed to working to ensure their opportunity zones are used to improve the lives of their residents and the communities they call home.

Under the program, investors can defer capital gains from their taxable income if they reinvest the gains in a qualified opportunity fund. The funds are required to invest 90 percent of their assets into qualified opportunity zone businesses, which are required to own substantially all qualified property.

“5 Things City Leaders Should Know About Opportunity Zones”

Legislators wrote the law to provide maximum flexibility, but most investors have stayed on the sidelines waiting for more definitive answers from regulators. Last week, the IRS and Treasury Department released the first iterations of regulations to provide investors with more clarity over which sort of investments qualify and which do not.

Here’s a rundown of four key takeaways for cities:

  1. “Substantially all” means 70 percent.
    The legislative text requires that a qualified business have “substantially all” qualified zone property, which had investors asking what constituted “substantially all.” The proposed rules clarify that qualified businesses must retain 70 percent or more of their assets in the zones. This provision has drawn some criticism since it could result — when coupled with the 90 percent portfolio requirement for the funds — in a situation in which only 63 percent (90 percent x 70 percent) of a fund is putting money into the zones.
  2. Safe harbor for working capital.
    Many investors expressed concerns about the requirement that gains be invested in qualified property within six months. Specifically, commenters argued that developing property or starting a business can easily take more than six months. The regulation allows qualified businesses to hold working capital for up to 31 months, if they have a written plan outlining how the capital will be used to comply with Opportunity Zone standards.
  3. Opportunity Zones are only for capital gains.
    While most observers assumed this was the case, the actual legislative text merely mentioned “gains.” Proposed regulations clarified that only capital gains may be deferred when reinvested in qualified funds.
  4. Investors seem satisfied.
    There is no doubt that the IRS and Treasury will need to promulgate additional guidance and rulings to answer remaining questions, but investors have by and large heralded the flexibility of the proposed regulations as a major first step in the right direction.

Cities should consult with their financial management consultants and local private and philanthropic partners to make sure they are prepared when the investments start being made. NLC will continue to analyze and provide resources on the program in the future.

More resources on Opportunity Zones:

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About the Authors: Brian Egan is NLC’s Principal Associate for Finance, Administration and Intergovernmental Relations. Follow him on Twitter @BeegleME.

 

mike_wallace_125x150Michael Wallace is the Program Director for Community and Economic Development at the National League of Cities. Follow him on Twitter @MikeWallaceII.