The 2017 tax overhaul was supposed to spur $100 billion in investments across the country through the designation of more than 8,700 areas as Opportunity Zones. Investors could reduce or postpone taxes on profit from businesses, partnerships and stocks by reinvesting in the Opportunity Zones. They could also avoid future profits from those reinvestments, provided they make substantial improvements.
To get the full benefit, investors would have to buy into eligible projects by the end of 2019. To fully shelter 2018 profits from hedge funds and other partnerships, the deadline was June 29.
The land rush hasn’t started. In January, only half of real estate investors surveyed by research firm Preqin were considering investing in Opportunity Zones. More than 90 percent weren’t even involved in an Opportunity Zone project at the time of the survey.
Joe Panepinto, Panepinto Properties
The biggest reason for the hesitation is that the rules to take advantage of Opportunity Zones have only begun to be clarified. The IRS and Treasury Department haven’t released the type of detailed guidance that investors need before they are confident enough to move forward. Final regulations on the zones were delayed by the government shutdown earlier this year and have yet to be made public.
Some of the areas that need to be addressed include the treatment of undeveloped land, refinancing and whether a property can have debt higher than its basis. How are trusts or foreign taxpayers treated? Is the recapture of debt exempt? How does the provision work if a company conducts most of its activity outside their physical location in a designated zone?
A second concern about an Opportunity Zone investment is liquidity. To take full advantage of the tax break an investment must be locked up for 10 years. People who pull money out before 10 years will face a taxable event. It is still unclear what would happen if an investor dies or there is another liquidity event (i.e. — condemnation) before 10 years have passed.
A third concern is the risk of disqualification, which would mean the investor no longer gets the tax break for a development. For instance, the provision requires that newly constructed buildings must obtain certificates of occupancy within a certain time. A failure to do so puts the investment out of compliance, which may become problematic if the project is delayed or the market stalls and additional development is not warranted.
Perhaps the biggest problem with opportunity zones is that there are not many projects ready to go that have a decent chance of being successful. Whether within an Opportunity Zone or not, projects in most high-value locations have an equally high barrier to entry by virtue of receipt of the requisite permits and approvals needed to commence construction.
Accordingly, while a developer or investor may be eager to expend Opportunity Zone money, it is not possible to make the required improvements and other capital expenditures within the appropriate time frames to capture the benefits of the act. Those that are shovel-ready have already had their finances in place for a while and are being constructed. Those that are not, continue to scramble and may not be ready. The trick is finding the right opportunity within the zone that is ready to move forward.
Even so, developers should not completely rule out Opportunity Zones projects. Once the rules are clarified, the zones could lead to very fruitful investments. The following are some guidelines for considering a project within an Opportunity Zone:
1) Determine the employment and transportation capacities of the area. Your project has more of a chance to succeed if you can determine that there is easy transportation access to jobs in adjacent communities and that there are a reasonable number of entry-level positions in your project’s own community.
2) Seek local capital. Local banks, community investors and venture capitalists should be in the mix when it comes to revitalizing an area because they are imperative to the development of a thriving ecosystem.
3) Work within already existing revitalization efforts. Many communities have business improvement districts, redevelopment areas, local development corporations and business accelerators. Tap into these institutions or agencies to capture the best local practices that can help your project succeed.
4) Take advantage of local and state assistance. Many local governments and states have added incentives that can go hand-in-hand with the tax breaks that Opportunity Zones present. Tailoring your project to gain those incentives could make a major difference in whether a project is worthwhile.
5) Assemble the same high-quality team that you would for any real estate investment. While the Opportunity Zone may offer substantial tax advantages, those breaks won’t overcome a bad real estate decision or a poor execution of your business plan. The team needs to include members with substantial investment, tax and finance experience and knowledge.
The problem is, regulations haven’t really been clarified – but there are properties that could be success stories.
—By Joseph Panepinto, president and CEO of New Jersey-based Panepinto Properties.