Although qualified opportunity funds (QOFs) have been making headlines for raising millions of dollars nearly overnight for use in qualified opportunity zone (QOZ) zone investing, many critics of the program have complained that opportunity zones are great for fundraising, but not necessarily for spurring on development in areas that need it. New proposals released last month by the Treasury and the IRS could change that, however, and create a new-office boom in the process.
Why Things Have Been Slow
When the opportunity zone program regulations were first released, investors rushed to invest in QOFs in order to get their tax-protected dollars into a fund in time to reap the full benefits of the program. Those benefits include reduced capital gains, forgiven capital gains taxes, and even some tax-free profits under certain circumstances if an investor leaves their money in the fund for a long enough period of time. Many investors selected funds managed by individuals or entities they trusted even though they did not know exactly where the fund would invest or how the managers would deploy the capital. Then, many fund managers opted to wait for the IRS and the U.S. Treasury Department to release clearer rules on QOZs before making a move, which meant that millions of dollars sat in waiting while the government worked to clarify its program.
One of the main reasons fund managers opted to wait to begin investing is that the opportunity zone program, which is part of the 2017 Tax Cuts and Jobs Act, was intended not so much to spur real estate investment in an area but, rather, to instigate business development. Many of the opportunities best suited for QOZs lie in the commercial real estate sector, particularly when it comes to commercial real estate space for offices, businesses, or retail entities. However, program guidelines require that at least half of the income from a business funded by a QOF must come from within the QOZ, meaning that developers could have difficulty filling vacancies and meeting the requirements since tenants who had previously been outside the QOZ would not qualify.
The recent ruling on this clears up the matter. “This is going to make it easier for businesses to qualify and it is going to be easier to lease office space,” said Pebb Capital’s fund manager, James Jago. This is good news for QOFs and QOZs because it makes it more likely that there will be more building and more businesses in the zones.
Breaking Down the Changes and Updates
One of the biggest stalling points for many developers revolved around how properties built in opportunity zones could be refinanced after they had been renovated or construction was completed. Many fund managers also were not sure how much time their funds would actually have in which to buy and reinvest in QOZs. This led to a great deal of uncertainty and slow going on the office and business side of the opportunity zone program, while more traditional residential real estate developers were able to forge ahead.
Thanks to new clarifications to the program, businesses operating in opportunity zones can qualify for the program and associated tax breaks if half of the wages or hours worked for the business located in the QOZ are earned or worked in the QOZ. This means a large software company, for example, can leverage the tax breaks for the division of the company housed in the QOZ. Similarly, start-up businesses will be able to work in these areas even if they serve a national customer base.
“For the incubators, the start-ups, there is now going to be a lot of action,” predicted Jago.
Will Low-Income Communities Benefit from the Office Boom?
One concern many proponents and critics, alike, of the opportunity zone program point out is that these office booms may begin in QOZs that arguably do not “need” the money the way other areas of the country need it. For example, critics say that the QOZ in Loving County, Texas, where the per-capita income is the highest in the entire state, does not need an opportunity zone and may pull resources from other lower-income areas. However, other critics worry that opportunity zone investing could cause communities to gentrify, ultimately driving out the original residents entirely.
“The big policy question is whether the Opportunity Zone investments will…actually improve the lives of those who live there,” said strategic advisor to foundations, families, and asset managers pursuing “impactful portfolios” Steve Godeke.
Tell us what you think:
- Is the opportunity zone program a good one?
- Will it work the way it was intended?
- Are you invested in a qualified opportunity fund?
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