Treasury Releases Highly Anticipated Rules for ‘Opportunity Zones’

October 19th, 2018

By Bill Lucia, Senior Reporter - Route Fifty

How the Opportunity Zones program will work in practice began to come into clearer focus on Friday as the U.S. Treasury Department issued highly anticipated regulations for the economic development initiative, created under last year’s massive tax overhaul.

The proposed rules focus on two broad areas: the establishment and operation of the special funds that can make investments through the program, and the tax breaks for capital gains that individual taxpayers and companies funnel into those funds.

“We anticipate that $100 billion in private capital will be dedicated towards creating jobs and economic development in Opportunity Zones,” Secretary Steve Mnuchin said in a statement.

“This incentive will foster economic revitalization and promote sustainable economic growth, which was a major goal of the Tax Cuts and Jobs Act,” he added.

Senior Treasury Department officials said during a conference call with reporters on Friday that the draft guidelines should provide enough information for funds to confidently begin operating, and for taxpayers to invest in the so-called Opportunity Funds.

The guidance does not answer all of the questions that currently surround the program and Treasury anticipates issuing a second round of guidance before the end of the year.

One basic but important issue that the proposed rules clarify is that only capital gains, from the sale of assets such as stock, are eligible for the tax breaks offered under the program.

Taxpayers who qualify to make investments include: individuals, corporations, partnerships, regulated investment firms, real estate investment trusts, and estates and trusts.

Investments through the program can’t be issued as debt. They have to be equity investments, like stock or a partnership stake in a business.

For a business to be eligible for investment from an Opportunity Fund it needs to meet certain criteria outlined in the rules.

One is that 50 percent of the gross income of the business must come from activity in one of the zones, which have been designated by states and the IRS as eligible for the program.

Another is that 70 percent of the business’ tangible property has to be used in the zone. This 70 percent figure sets a standard for what some observers have referred to as the “substantially all test” that is outlined in the legislative language that created the program.

The program’s tax incentive allows a taxpayer to sell an asset and to take the gains on that asset and invest them in an Opportunity Fund without paying any tax on the gain.

Deferred gains like these, invested into the funds, are recognized as taxable on the date the investor cashes out of the fund, or Dec. 31, 2026. If the Opportunity Fund investment is held for five years, then 10 percent of the deferred original gain is tax free. That tax-free threshold rises to 15 percent if the investment is held for at least seven years.

An added benefit for the taxpayer is that if an investor holds their investment in the fund for 10 years or more, then 100 percent of the gains on their investment through the fund are not taxed.

About 8,700 census tracts around the U.S. are currently designated as Opportunity Zones.

Some Opportunity Funds are already up and running. But experts say that the Treasury regulations are a key step toward building the program to its full potential.

A concern with the program, is that the Treasury guidelines would be written in a way that skews investments toward real estate, as opposed to other types of businesses. But the senior officials on Friday’s call insisted that this was not the case. “There’s nothing in here that slants these rules in favor of real estate,” one of the officials said.

“The whole goal,” they added, “is to drive activity in the zone.”

This story will be updated.