A key piece of legislation aimed at spurring continued investment in Opportunity Zones may be stalled in Congress until next year.
When the Opportunity Zone program came into being as part of the Tax Cuts and Jobs Act (TCJA) of 2017, the tax benefits for individual investors were one of its main selling points. Aimed at boosting investment in depressed areas, the legislation gave Qualified Opportunity Fund investors a tax deferral on their capital gains until 2026. Those who held their investment for five years would also receive a tax break. of 10% on their taxable earnings, while those committed to a 10-year hold will not be subject to tax on their eligible earnings until 2047.
The Zones of Opportunity Transparency, Expansion, and Improvement Act (HR 5761), introduced in the House of Representatives last fall, would defer capital gains on qualified Opportunity Zone investments until 2028, two years longer than the current program limit. It would also reinstate reporting requirements for Opportunity Zones, refine the zoning to exclude non-economically disadvantaged areas, and create a special fund to encourage public and private investment in the program. By all accounts, the bill, co-sponsored by Republican and Democratic representatives, has bipartisan support and a good chance of eventual passage. However, the impasse in Congress means it likely won't pass until after the November election.
“This year, there's little chance of tax legislation, and that's because we're right before the election,” he said. Anya Coverman, president and CEO of the Institute for Portfolio Alternativesan advocacy group for the portfolio diversification investment industry.
While a bill passed the House of Representatives earlier in the year — the Tax Relief for American Families and Workers Act — it did not include the Opportunity Zone provisions. It also stalled in the Senate because some Republican senators, including Senate Finance Committee member Mike Crapo (R-ID), would prefer to delay tax policy changes until 2025, when many of the TCJA's provisions expire. Coverman noted.
“And also, being an election year, the Republicans don't want to have a big tax win on the part of the Democrats,” she added.
HR 5761 has bipartisan support, “but there just isn't much of a window to pass tax legislation in the current tightly divided Congress,” agreed John Lettieri, CEO of the Economic Innovation Group (EIG), a bipartisan public policy organization focused on the American economy. Lettieri pointed to a similar hurdle emerging with child tax credit legislation.
“At worst, I predict Opportunity Zones will be a significant part of the discussion next year as tax policy returns to the forefront thanks to the expiration of key provisions of the Tax Cuts and Jobs Act,” he wrote. in an email.
Will investors care?
Deferring capital gains taxes is essential for investors considering putting their money into Opportunity Zone funds and for the program to achieve its goal of helping underserved communities, industry insiders say. Given how long it took after TCJA's passage to clarify the Opportunity Zone provisions and educate investors on its benefits, the program has yet to realize its full potential, according to Kelly Ann Winger, CEO of Alternative Wealth Partners LLC, an emerging private. capital manager. Funds managed by Alternative Wealth Partners have investments in projects located in Opportunity Zones, including manufacturing, energy and infrastructure businesses.
Until now, individual investors have primarily used the Opportunity Zone program to mitigate taxes on their capital gains when they could not do 1031 exchanges, which are more limited, Arm noted. But today, more private equity and venture capital players are considering the program because it will allow them to pursue long-term returns through a tax-free vehicle.
“I think it's important that (the program) continues because there was a lot of wasted time in the first five years of the program,” Winger said. “We're going to start seeing the results of people who first invested using this strategy in 2017 in the next couple of years, as those tax-free capital gains outflows start in 2027. I think a lot of people didn't know all the right information; there is still not much clarity about how the program works or the incentives that can be stacked.”
Winger added that investors could reap big returns if they put their money into Opportunity Zones over the next five years, provided Congress extends the program.
A 2023 working paper from the US Office of Tax Analysis found that for the 2020 tax year, individual investors accounted for approximately 85% or 24,000 electronically filed reports for qualified investments in Qualified Opportunity Areas. The Bureau also determined that the average individual investor in a Qualified Opportunity Fund had an adjusted gross income of approximately $730,000. The average amount invested in these funds was about $1 million, with an average deferred profit of about $250,000.
Professional services firm Novogradac & Company LLC reported that from the beginning of the Opportunity Zone program through the end of 2023, Qualified Opportunity Funds raised at least $37.62 billion. In 2023, Qualified Opportunity Funds, tracked by Novogradac, reported that their fundraising raised $3.54 billion in capital for 1,461 funds. Most of the funds tracked by the firm (66%) raised less than $10 million, indicating that they focused on a specific project rather than multiple deals, Novogradac researchers noted.
A real estate investment firm that focuses on raising money for such single-asset Opportunity Zone funds is based in Richmond, Va. Capital Square. The RIAs the firm works with value the ability to perform due diligence on specific deals in an asset's funds and see what they're allocating money to, according to Adam Stifel, chief development officer. The company has raised about $250 million from retail investors for eight single-asset funds. Most of the assets include multifamily development.
It took a while for investors to become educated on how Opportunity Zones work, Stifel said. However, “It's now almost as common a word in the tax world as the 1031 is, and the program needs time to take advantage of that. I think most people understand the basics of what the Opportunity Zone is at this point and the level of interest is really high on the retail side.
He noted that the tax advantages of Opportunity Zone investments are an important selling point. To date, Capital Square has completed projects in its Opportunity Zone funds, stabilized and refinanced them prior to the sunset of the 2026 capital gains deferral program. If the program expires less than two years from now, Capital Square could still raise capital from institutional investors and other types of LPs. However, interest from individual investors is likely to fade, according to Stifel.
“It's hard to overstate how significant that 10-year benefit is,” he said. “There may be a slowdown and less interest from our investor base if we are no longer able to achieve a refinancing distribution before our investors' initial capital gains tax is paid.”
Both Stifel and Winger believe the extension bill will eventually fit. Since Congress passed the program during the Trump administration if he wins a second term, there would be little reason for him to undo his legacy by dismantling the program, Winger noted. Likewise, if Biden wins in November, the Democratic party will want to keep investment flowing to underserved areas, she said.
Coverman is more cautious about how things might develop. She noted that Congress is likely to be more concerned about spending next year than it was in 2017. That means supporters of the Opportunity Zone program must show that its benefits will outweigh the negative budget outcome that it will to receive an extension of his tax benefits.
“It will be important to keep this policy supported on a bipartisan basis, but this will be done by showing policymakers the positive impacts (of the program),” she said. “We're at the beginning of what I think is going to be a very big and nuanced conversation next year.”