What are Opportunity Zones?
Opportunity Zones (“OZs”) are census tracts generally composed of economically distressed communities that qualify for the Opportunity Zone program, according to criteria outlined in 2017’s Tax Cuts and Jobs Act.
Up to 25% of low-income neighborhoods that meet the income qualifications of the program (and up to 5% of non-low income tracts that meet other income and geographic requirements) in each state, district, or territory can be designated as OZs. Areas certified as OZs retain their designation for ten years. There are more than 8,700 qualified OZs in the U.S. and U.S. territories.
California’s Governor was authorized to identify and recommend OZ designations statewide. In April 2018, the Governor’s recommendation was approved, granting 879 census tracts as Opportunity Zones. Riverside County has 49 designed OZs, two of which are located within Banning (map below).
The OZ program is intended to develop economically depressed areas. These areas have specific criteria and are designated on a census tract basis, which is a geographic area comprised of approximately 4,000 people. In order to qualify for an OZ, the census tract must have meet the following low-income requirements as defined by [U.S. Internal Revenue Code Section 45D(e)]:
- A poverty rate of at least 20%; or
- A median family income of:
- No more than 80% of the statewide median family income for census tracts within non-metropolitan areas.
- No more than 80% of the greater statewide median family income or the overall metropolitan median family income for census tracts within metropolitan areas.
Description of Physical Boundaries:
Census Tract 06065044101 - West: Sunset Ave., North: Nicolet St., East: San Gorgonio Ave., South: Interstate 10
Census Tract 06065044200 - West: San Gorgonio Ave., North: North of Summit Dr., East: Hathaway St., South Interstate 10
Source: CDFI, CIMS Mapping Tool: https://www.cdfifund.gov/Pages/cims3.aspx
Why Was the Opportunity Zone Program Created?
The Opportunity Zone program was created to stimulate private investment in OZ communities in exchange for capital gain tax incentives. The program was designed to stimulate private sector investment to develop low-income census tracts across the U.S. There is an estimated $6.1 trillion of unrealized private gains held by U.S. households. In exchange for investing in communities within Qualified OZs, investors can access capital gains tax incentives both immediately and over the long term.
OZs differ from other programs designed to encourage private investment in low-income areas through tax advantages. OZs are less restrictive, less costly, and less reliant upon government agencies to function. Existing programs, such as New Markets Tax Credit (NMTC) and Low Income Housing Tax Credit (LIHTC) programs are limited to annual Congressional approval and/or tax credit allocation authority limits.
To receive access to capital gain tax incentives, investors can invest in Qualified Opportunity Zones through Opportunity Funds (more on this below), that can self-certify without the need for approval from local level government agencies or the U.S. Treasury Department. Opportunity Funds are managed entirely in the private market with the administration of the funds left up to fund managers rather than government agencies or investors. Also, there is no cap on the amount of capital that can be invested into qualified OZs.
How Investing in Opportunity Zones Works
A distinct advantage for investors engaged in funding projects in OZs is the ability to access capital gains tax incentives available exclusively through the Opportunity Zone program. To access these benefits, investors must invest in OZs specifically through Opportunity Funds.
A qualified Opportunity Fund is a U.S. partnership or corporation that intends to invest at least 90% of its holdings in one or more qualified Opportunity Zones (IRC section 1400Z-2). Each Opportunity Fund must ensure compliance with guidelines of the OZ program in order to be able to offer tax incentives.
As an economic growth stimulator, there are restrictions on the types of investments in which an Opportunity Fund can invest. These investments are called “Qualified Opportunity Zone property,” which is defined as any one of the following:
- Partnership interests in businesses that operate in a qualified Opportunity Zone.
- Stock ownership in businesses that conduct most or all of their operations within a qualified Opportunity Zone.
- Property such as real estate located within a qualified Opportunity Zone.
There are rules that govern each of these three investment options and are limited to ensure that investments made are tied to improvements in the OZ communities. Please check with your Opportunity Fund Administrator.
In general, Opportunity Funds are limited to investment in the construction of new buildings and the substantial improvement of existing unused buildings. If an Opportunity Fund invests in the improvement of an existing building, the investment in the improvement of the building must be more than what was paid to buy the building/land. Whether ground up construction of substantial rehabilitation, the project must be completed within 30 months of purchase.
Tax Advantages of Investing in Opportunity Zones
With injection of private investment into qualifying areas of the Opportunity Zone program and investing in Qualified Opportunity Zones through Qualified Opportunity Funds, investors are entitled to substantial capital gain tax incentives immediately and over the long term.
For example, when an investor divests an appreciated asset, such as stocks or real estate, they realize a capital gain, which is a taxable event. Under the Opportunity Zone Program, if an investor reinvests a capital gain into an Opportunity Fund, they can defer and reduce their tax liability on that gain. Beyond that, they can also potentially receive tax-free treatment for all future appreciation earned through the fund. Together, these tax incentives can boost after-tax returns for Opportunity Fund investors:
- Those who invest realized capital gains into a Qualified Opportunity Fund can defer paying capital gains tax for those earnings until April 2027 for investments held through December 31, 2026. Gains must be invested in a Qualified Opportunity Fund within 180 days in order to qualify for any tax treatment available under the Opportunity Fund program.
- Those who hold their Opportunity Fund investments for at least five years prior to December 31, 2026, can reduce their liability on the deferred capital gain principal invested in the Opportunity Fund by 10%. If the investment is held for a minimum of seven years prior to December 31, 2026, the tax liability can be reduced by 15% total.
- Those who hold their Opportunity Fund investment for at least 10 years can expect to pay no capital gains taxes on any appreciation in their Opportunity Fund investment. That’s because Opportunity Fund gains earned from Opportunity Zone investments can qualify for permanent exclusion from the capital gains tax if the investment if held for at least 10 years.
OZ tax benefits must adhere to a timetable that investors must follow in order to maximize the tax advantages available through the OZ program.
The Opportunity Zone program offers substantial potential to aid in lifting economically distressed communities through a private capital investment approach. Investors have the ability to participate in the transformation of economically disadvantaged communities by stimulating private investment, they also can access numerous capital gains tax incentives by adhering to OZ program guidelines.
If you have additional questions about the Opportunity Zone program in Banning, please contact the City Manager’s Office at (951) 922-4860 or via email at email@example.com.