Opportunity knocks

Takeaways

  • The Opportunity Zone program provides a tax incentive to invest in economically distressed communities.
  • Investment in Qualified Opportunity Funds allows investors to defer some or all of their capital gains from federal taxation.
  • Opportunity Fund investments potentially provide another alternative for investors seeking to allocate a portion of their portfolio to place-specific impact investments. 

One of the least publicized yet significant provisions of the U.S. tax overhaul is a new program offering tax breaks for investing in economically distressed communities.

The Opportunity Zone provision of the Tax Cuts and Jobs Act allows investors to defer capital gains from the sale of appreciated assets by rolling the gains into vehicles, known as Qualified Opportunity Funds, designed to spur economic activity in poverty-stricken parts of the U.S.

The aim is to foster growth in urban and rural areas that have lagged behind the national rate of economic expansion, according to a new UBS Chief Investment Office (CIO) report . Investments that could qualify under the program range from affordable housing and commercial real estate development, to financing for startups, infrastructure and energy, such as solar power.

“Opportunity Fund investments potentially provide another alternative for investors seeking to allocate a portion of their portfolio to place-specific impact investments,” says Andrew Lee, Head of Sustainable and Impact Investing for UBS, who co-authored the report.

Under the program, investors can roll unrealized capital gains into a Qualified Opportunity Fund and defer federal taxes on those profits as long as they remain within the fund. Investors are eligible for increasing levels of tax relief if they keep their investment in the Qualified Opportunity Fund for at least five or seven years, and can permanently avoid capital gains taxes on any gains accrued on the Opportunity Fund investment if they retain it for at least 10 years.

The program “implicitly promotes a longer-term investment perspective by offering the biggest tax breaks to investors willing to commit capital for at least a decade,” says Jonathan Woloshin, CFA, Head Americas Equities, UBS, another co-author of the CIO report.

Critics of the program warn that the tax breaks will accelerate the pace of gentrification in urban areas, displacing low-income residents and unintentionally harming the very individuals the law was designed to help. They also note that benefits may accrue to communities for which the program is not intended, such as neighborhoods adjoining prestigious universities with an abundance of students on limited incomes.

Fortunately, CIO notes, a preliminary analysis by the Brookings Institution concludes most of the census tracts designated for the program by the nation’s governors thus far are deeply impoverished and will benefit from incremental investment.1

The Opportunity Zone program “implicitly promotes a longer-term investment perspective by offering the biggest tax breaks to investors willing to commit capital for at least a decade.”

—Jonathan Woloshin, CFA, Head Americas Equities, UBS

“We expect the Opportunity Zone program to capture considerable interest among investors whose existing investments have appreciated along with the nation’s economic recovery,” CIO writes.

Some details about Opportunity Zones are still being ironed out as the U.S. Department of Treasury develops regulations, which are expected to be released this summer. Investors should consult their tax and legal advisors about specific tax implications.

Learn more: Read the full CIO report, “Real estate markets—Opportunity knocks in tax-advantaged Opportunity Zones.

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