The Trump administration Wednesday released rules for a tax break designed to encourage economic development in distressed areas throughout the U.S. by making it easier to invest in businesses and real estate in low-income communities.
Wall Street banks, private equity firms, real estate developers and others have been eagerly awaiting the regulations, which the administration said will spur $100 billion of investment into the more than 8,700 areas designated as “opportunity zones” in the 2017 federal tax overhaul.
The 169-page proposal gives investors interested in these areas additional leeway and a more flexible timeline, a Treasury official told reporters Wednesday. The rules also give investing funds a one-year grace period to sell assets and reinvest the proceeds, thus avoiding penalties intended to prevent funds from sitting on the cash.
The new Treasury regulations give funds six months from when they receive money to purchase assets that qualify for the special tax breaks. The rules also allow land and vacant buildings to be investments eligible for an opportunity zone fund, the Treasury official said.
The tax breaks – which allow some investments to appreciate without being subject to capital gains levies – are bringing development to marginalized areas, President Donald Trump said Wednesday at a White House event to highlight the opportunity zones.
Investors previously have shied away from developing distressed areas, Trump said, but when they see tax rates “all the way down to a big, fat beautiful number of zero” they start “liking the location.”
Birmingham unveiled its strategy for pursuing opportunity zone investment last week when the developer of the vacant Stonewall/American Life building said he was moving forward with a $24 million renovation of the building using the opportunity zone tax breaks. The New Ideal Lofts project in downtown Birmingham has also said it plans to capitalize on the opportunity zone benefits.
Alex Flachsbart, founder of Opportunity Alabama, said last week that investors and potential projects have been awaiting the Treasury’s guidance but are poised to make investments.
“We’re very hopeful, based on initial guidance that we’ve gotten publicly from Treasury, that that is going to throw the doors wide open for investment into the exact kinds of startups and operating companies in neighborhoods that this program was supposed to promote in the first place,” he said.
Waiting for rules
While there’s been a flood of interest in opportunity zones, many people have delayed investments to see if the rules make sense for the projects and businesses they have in mind. Skeptics of the provision will be looking for guardrails in the regulations to prevent investors from claiming a generous tax break for developments that do little to help the poor.
Under existing tax law, investors race to meet deadlines that require them to invest their capital gains income within 180 days of selling the stock or business.
The rules permit more flexibility to include more than one investment in a fund, the official said. Investors would like to create multi-asset funds to reduce the risk of a single bad project wiping out any return. The rules allow investors to get special tax treatment if they’ve held their stake in the fund for at least 10 years, even if the fund didn’t own the asset for a full decade, the official said.
Investors can also buy into a fund by directly purchasing an interest or buying another partner out.
Investors claim the breaks by taking capital gains income they’ve already earned and deploying it in the distressed areas. The provision, part of the 2017 Republican tax overhaul, allows them to defer those tax bills until the end of 2026 and can reduce the total amount of tax they owe. The new investments in the opportunity zone can grow tax-free if investors hold them for at least a decade.
Several prominent investors, such as Goldman Sachs Group Inc., hedge fund EJF Capital LLC and New York-focused RXR Realty LLC, have already begun making investments in opportunity zones or are raising money to do so. These funds are rushing to invest in some urban areas most likely to produce large returns.
Some critics argue the law is written so loosely it could become a handout to the wealthy, juicing returns on projects they would have pursued anyway. Others say that the bulk of investment could go to zones in places like Brooklyn and Portland, Oregon, that have little trouble attracting investment.
The most recent rules follow regulations from October to instruct investors on how to qualify for the tax breaks.
The regulations also address a problem flagged by many investors looking to create startup businesses: the requirement that businesses generate at least half their gross income within their opportunity zone. That works for an apartment building or a grocery store, but would be a disaster for a business hoping to manufacture a product to be sold widely, or provide services online.
The rules give funds three different ways to prove they are conducting enough business from within the zone. Treasury will allow businesses to qualify if at least 50 percent of the hours the employees work are within the zone, as long as it performs at least half of its services within the area, or if there are significant management and operational functions present. Businesses can also appeal their specific case. Fifty percent of the sales do not have to come from within the geographic zone, the official said.
“We are trying to be as user-friendly as we can within the context of the law,” Treasury Secretary Steven Mnuchin said at the White House event where about 20 governors and several hundred local leaders were invited to discuss how the tax-incentive program works in their communities.
This round of regulations doesn’t impose reporting requirements that would allow the IRS to assess penalties on those who violate the rule. The Treasury Department released a document Wednesday soliciting public input on how to best measure economic activity in opportunity zones and how to collect this information.
U.S. Sens. Cory Booker, a New Jersey Democrat who’s seeking his party’s presidential nomination, and Tim Scott, a South Carolina Republican, are planning to introduce legislation that would require the IRS to collect data from tax break recipients to show how investments are altering the economic conditions in the areas where they operate.
Booker and Scott were both early backers of opportunity zones in Congress before the provision became law. Their law would require the IRS to compile data about how many funds have been created, what assets they own, how many jobs have been created and how poverty levels have changed.
(With assistance from Alyza Sebenius and Noah Buhayar. Contact the reporter at [email protected].)