Opportunity Zones are economically disadvantaged communities in the United States that have been officially designated by states, and then certified at a federal level, so that private investment in these areas can be made eligible for special tax treatment.
The purpose of Opportunity Zones, which were introduced in 2017 as part of the Tax Cuts and Jobs Act (which included the Investing in Opportunity Act), is to catalyze the use of private capital (instead of taxpayer funds) to stimulate growth in these traditionally marginalized communities.
As an investment vehicle, they offer tax incentives which encourage investment in underserved and undercapitalized communities hoping to reduce inequality. What is underserved and undercapitalized? The investment incentives created by this program represent a remarkable opportunity to catalyze entrepreneurship and promote long-term investment in economically distressed communities.
Opportunity Zones have captured the attention of funders, investors, asset managers, policymakers, and community development financial institutions. The new policy will unlock billions of dollars to support thriving community development projects and create economic opportunity in identified distressed areas while improving end beneficiaries wellbeing. As interest in Opportunity Zones rises, early participants in the Opportunity Zones market must maintain focus. Achieving goals, such as positive economic and social outcomes will define the market. The U.S. Department of the Treasury in June 2018 certified over 8,700 census tracts as Qualified Opportunity Zones in every U.S. state and territory.
Opportunity Zones Tax Benefits and Incentives
The program provides three main tax benefits for investing unrealized capital gains in Opportunity Zones:
As per Tax Policy Center, there are three steps to the the tax benefits.
- Temporary deferral of taxes on previously earned capital gains. Investors can place existing assets with accumulated capital gains into Opportunity Funds. Those existing capital gains are not taxed until the end of 2026 or when the asset is disposed of.
- Basis step-up of previously earned capital gains invested. For capital gains placed in Opportunity Funds for at least 5 years, investors’ basis on the original investment increases by 10 percent. If invested for at least 7 years, investors’ basis on the original investment increases by 15 percent.
- Permanent exclusion of taxable income on new gains. For investments held for at least 10 years, investors pay no taxes on any capital gains produced through their investment in Opportunity Funds (the investment vehicle that invests in Opportunity Zones).
To read the official Internal Revenue Code (1400Z-2) related to the special rules for capital gains invested in opportunity zones, click here.
The Economic Innovation Group (EIG) analyzed data from the Federal Reserve and found that amongst U.S. households there are $2.3 of unrealized capital gains if one examines just stocks and funds. That was in 2016. In 2017, that number was $3.8 trillion. Considering the unrealized capital gains held by U.S. corporations as well, there are over $6 trillion eligible for Opportunity Zone investing.
It should be made clear that Zones are not part of any tax credit program. They are governed by IRS code sections which changes the tax treatment of capital gains.