November 27, 2018
By Erik Parrish
America has long been termed “the land of opportunity.” The phrase dates back to the 16th century when immigrants came to the land to enjoy a fresh start, build a new future for their families, and partake in the abundance that the land had to offer. The immigrants took full advantage of the opportunity, both in positive and negative ways as stories of history were written.
As cities grew, the new became old, the prosperous became distressed, and communities became fractured. The separation of wealth and poverty became more severe in certain areas, whether from politics, governance, industry, or simply from natural destruction found prevalently on the south and east coasts.
Once communities become distressed, it is very difficult to turn them around without significant resources from the government. Investors see the areas as high risk and more effort for a low return, if any. To offset the costs of turning the communities around, the government often has to raise taxes on individuals and businesses of prosperous areas to redistribute the resources into these distressed areas. Raising revenue to do this is both unpopular and challenging as significant work must be done to turn the tide.
Instead of raising taxes, a small group of socially conscious tech entrepreneurs and politicians decided to leverage the resources differently. In trade for tax breaks, entrepreneurs and developers would invest in infrastructure in the distressed areas, bear the risk, and also be rewarded for their efforts. President Trump and a number of other politicians supported the idea and program. Legislation was signed for specific tracts of land to receive special tax benefits to help offset the risk and incentivize investors to help turn communities around.
With that, opportunity zones were designated by each state governor. Guidance was placed into effect for investors to be able to establish opportunity funds so capital could be deployed into projects and new businesses in the zones. How can you be a part of the largest economic development program undertaking that America has taken?
Be cautious: Guidance is out and you can invest in projects, but only at a basic level confidently. There are still many details that the US Treasury needs to clarify to ensure your investment will qualify for all the tax deferral, basis step up on deferral, and permanent exclusion. The benefits are an all or nothing benefit so the benefits could be none if a time or fact test fails. In some cases, it can be a steep penalty if funds are sitting on the sideline and not meeting the asset test.
Be proactive: This is a national opportunity and incentivized by federal tax benefits, but not necessarily state supported. Some states have decoupled from the federal tax deferral and exclusion, so investment gains will be taxed by the state. Oregon follows the federal, for now, but there is strong political pressure to not follow. This means you can contact your state representatives and ensure they know this helps Oregon have a competitive advantage for development or new businesses over states such as California that have decoupled.
Be involved: Opportunity funds will be most successful if the capital is deployed into a well-thought and executed plan for a property or business. Property development takes coordination with the city for permitting and hitting construction timelines so projects are completed within 30 months. Active management is needed to ensure the business is successful and the business property and revenues stay primarily in the opportunity zone.
Be smart: Finally, the development project or business needs to make sense. The tax benefits should be a reward for the risk undertaken. Remember, these are already distressed areas. Staying local is a good plan. The regulations on the funds are very thin, by design, so funds can be started and deployed easily. This leaves the door open for fraud, Ponzi schemes, and poor business planning that results in failure and negates the tax benefits.
Please reach out to us for technical details on this program. Kernutt Stokes is well prepared to help you navigate through opportunities you are considering.