Up to 6 trillion dollars could soon flow into low-income communities across the country through a new addition to the tax code called “Opportunity Zones.” Will entrepreneurs, nonprofits and other community members in these zones benefit, or will this be a tax break that drives unequal competition and displacement?
Right now, few if any nonprofit organizations and community stakeholders are even aware of Opportunity Zones, let alone are ready for this imminent “opportunity.”
What are Opportunity Zones?
A relatively low-profile provision of the 2017 tax bill called the Tax Cuts and Jobs Act allowed each state and federal territory to identify Opportunity Zones in their respective jurisdictions.
Opportunity Zones work very differently from earlier programs that may sound similar, like Empowerment Zones or New Market Tax Credits. That’s because this is a tax incentive, not a spending program.
People with capital gains (such as those earned in the stock market) can move the money into an “Opportunity Fund.” They can then defer the taxes on those gains, meaning they don’t pay capital gains tax until 2026, if they keep the money in the fund that long. When they do eventually pay capital gains taxes, they save 10-15% depending on how long they money stays in the fund.
The fund can invest in Opportunity Zones nationwide, and if they keep the money in the fund for 10 years, they don’t owe any taxes on the profit. This means, in short, it’s going to be very appealing for people to invest money in Opportunity Zones, which could lead to a lot of new capital flowing to these areas.
Where are the zones?
The authors of the Opportunity Zone provision intended for it to affect communities in both urban and rural areas that did not recover after the 2008 recession. In many cases these communities housed deep, entrenched poverty for decades only to see it further magnified when the recession hit.
After the tax bill passed last year, there was a 90-day period for states and territories to nominate zones. Enterprise Community Partners and the Economic Innovation Group tirelessly issued resources and counseled state agencies around the country to ensure every state and federal jurisdiction participated.
Their efforts paid off. All states participated and in mid-June, all proposed zones were officially approved by the IRS and Treasury. Here are the zones in our region:
In DC, the zones are mainly east of the Anacostia River, as well as in spots like McMillan Reservoir and Walter Reed which are currently slated for redevelopment.
In our region in Maryland, most zones are in Prince George’s County inside the Beltway, plus eastern Montgomery County and Germantown.
Northern Virginia’s zones are in southern Arlington, western Alexandria, and Fairfax near the western Alexandria border; along the Fairfax and Prince William Route 1 corridor, eastern Loudoun, and the Manassas area.
Who will benefit?
The Opportunity Zone program has come under criticism from some experts who worry that the tax breaks will not end up helping existing residents and business owners in the affected areas. The Brookings Institution’s Adam Looney asked, “Will Opportunity Zones help distressed residents or be a tax cut for gentrification?”
Real estate companies stand to benefit from the tax break, which could potentially be helpful in encouraging development of new homes and office spaces that wouldn’t have existed otherwise. However, Looney argued, “the value of the tax subsidy is ultimately dependent on rising property values, rising rents, and higher business profitability. That means a state’s Opportunity Zones could also serve as a subsidy for displacing local residents in favor of higher-income professionals and the businesses that cater to them.”
Timothy Weaver, writing in Citylab, said research from similar “enterprise zone” programs in the US and UK in the past found that “these policies almost inevitably result in tax giveaways for investment that would have occurred anyway.”
Claire Zippel of the DC Fiscal Policy Institute pointed out that “there is no requirement that investments provide any benefits for the community, such as affordable housing or high-quality jobs.”
How Opportunity Zones could create real opportunity
But for all the concern, there is real promise the Opportunity Zones could succeed where past attempts fell short. Opportunity Zones will attract an array of investors all with different tolerance for risk and return. This will hopefully yield a range of deals in size and scale, potentially opening doors for new entrepreneurs. Of course all deals will ultimately have to present a strong economic case for investment, but the long-term, flexible nature of the incentives create several potential use cases for Opportunity Funds beyond traditional real estate development projects.
It’s possible a bakery owner in Anacostia could get investment capital to expand operations. A group of nonprofits could collectively create an LLC to operate a job training facility along with some workforce housing. They could get the necessary start-up capital through an Opportunity Fund and pay investors with the revenue stream from the program. Assuming this aligns with the nonprofits’ missions, it’s legal for them to spin off this for-profit business, as it creates benefits the community needs.
Opportunity Fund money could help create an early childhood center that offers some or all of its slots below market rate to a diverse group of families. To make the investment more attractive, the center could also partner with a developer to provide on-site affordable housing for families and educators.
While there’s optimism these opportunities will be eligible for Opportunity Zone funding, it remains an open question.
First, the IRS and Treasury Department have to issue guidance on the Opportunity Funds. State and local governments will add local rules as well.
Several questions remain outstanding as we await the proposed rules. Who can invest in Opportunity Funds? What specific kinds of investments will qualify? When and for how long do the funds need to invest their money?
The answers will strongly affect whether the above scenarios are possible. If the hypothetical bakery owner operating in an Opportunity Zone wants funding for a tech platform to generate services/sales outside one, will she be able to use it for this purpose? Or will the rules favor someone with a bakery currently outside the zone who wants to expand into it — competing with her?
More is unknown than known, so far.
The clock is ticking
Receiving the maximum 15% break on the deferred capital gains taxes requires holding the investment for 7 years in a Opportunity Fund. But the deferral period ends in 2026. Therefore, people will need to invest in Opportunity Funds by the end of 2019 — next year — to get the full break. It’s expected there will be a big rush to put capital into these funds between the time the rules are finished and December 2019.
While we know that capital will need to be put into a fund by the end of 2019, there is no clear answer on when the fund needs to invest its money in Opportunity Zones. Depending on the answer coming later this summer, organizations hoping to receive funding may have to begin preparing now. This may be easier said than done.
Opportunity Funds can only make equity investments, where investors get shares of a business for example (as opposed to loans and other debt investments). It is well established that women and people of color have historically lacked access to common forms of equity investment, like venture capital. In fact, women of color receive only 0.2% of venture capital funding.
What you can do
For owners and businesses that have traditionally been left out of the equity investment market, support and guidance will likely be required to attract this new form of capital. Governments should further partner with private industry to create a stronger ecosystem of support for entrepreneurs. BEACON DC’s efforts to date and the DC Department of Small and Local Business Development’s events surrounding the annual Startup Week, provide good examples.
Communities should demand that local and state officials speak with businesses and organizations that provide services in Opportunity Zones before writing any rules. Ask that leaders truly include local feedback in the policies and ensure investments benefit existing residents. Too much regulation will discourage investment, while too little could increase the risk of displacement.
For philanthropists and potential investors: educate yourself and share what you know with local nonprofit leaders and small business owners. Commit to helping organizations navigate this opportunity and leverage your influence to create space at the table for inclusive participation. Build alliances amongst investors, philanthropists, residents and nonprofits alike.
If you have capital gains, consider if an Opportunity Fund is right for you and how you might use this tool to help your community. What is the return rate that you would actually accept and what is your goal for community change? Ask your financial advisor to learn more so that they can help you and others make responsible decisions.
For nonprofits: educate and engage your boards. Begin to position your organization to benefit from these new investments. If you operate or could operate in an Opportunity Zone, consider how equity investments can blend with existing tax credit programs to help expand your mission. In short, ready yourself.
Let’s work to ensure the “opportunity” reflects the full potential of our dynamic, courageous, and diverse communities.
Sara Gibson and Tom Bartlett are co-founders of 20°, an impact investing firm connecting more nonprofits to impact capital.