The Tax Cuts and Jobs Act of 2017 created a significant—and little-discussed—economic development program that encourages long-term investments in so-called “Opportunity Zones” by offering temporary tax deferral for capital gains re-invested in the Opportunity Zone and a permanent exclusion for gains from the Opportunity Zone investment. This program has the potential to be one of the most significant economic development programs in the country. Any person or business seeking to invest capital, raise capital, or that will recognize significant capital gains in the next few years should be aware of the benefits of this program.
What are Opportunity Zones? Opportunity Zones are low-income areas (determined on a census tract basis) that are designated by the governor of each state as Opportunity Zones. Each governor must designate his or her state’s Opportunity Zones from the pool of eligible low-income census tracts and certain contiguous tracts. Not every low-income census tract can be designated an Opportunity Zone. States are limited to designating 25% of their low-income tracts, and 5% of their contiguous tracts as Opportunity Zones. In Maine, Massachusetts, New Hampshire, and Rhode Island this translates into the following number of tracts:
State Low-Income Tracts Contiguous Tracts
Maine 31 2
Mass 137 7
NH 27 2
RI 25 2
Governors must designate their state’s Opportunity Zones by March 21; a governor may seek a 30-day extension of this deadline.
What are the tax benefits? Investments in Opportunity Zones must be made via “Opportunity Funds,” which are to-be created private sector investment vehicles that invest in Opportunity Zones. The potential tax benefits from investment are significant and include:
- A temporary tax deferral for the capital gains that are invested in the Opportunity Fund. The deferred gain is taxable on the earlier of (i) the date on which the investment in the Opportunity Fund is sold, or (ii) December 31, 2026.
- A step-up in basis for the capital gains invested in the Opportunity Fund. The benefit of the step-up increases the longer the investment is held: the basis of the original investment is increased by 10% if the investment is held by the taxpayer for at least five years, and by an additional 5% if held for at least seven years.
- A permanent exclusion from taxable income of capital gains from the sale or exchange of an Opportunity Fund investment, if the investment is held for at least ten years.
To receive the program’s tax benefits, investors must invest capital gains within 180 days of receipt in an Opportunity Fund.