Opportunity Zones: Hidden Gems in the Tax Cuts and Jobs Act

Newly created “Opportunity Zones” may bring a breath of fresh air to the Illinois economy while giving blighted communities a badly needed boost. By NATALIE ROONEY | Summer 2019



Illinois hasn’t had a lot to tout from an economic standpoint in recent years. It has the fifth largest GDP in the nation, but stories of fiscal woes and a worsening tax and business environment dominate the headlines. Now, a provision in the new U.S. tax law (Pub. L. No. 115-97, enacted Dec. 22, 2017) that created 8,761 “Opportunity Zones” across the U.S. may bring a breath of fresh air to the Illinois economy while giving blighted communities a badly needed boost.

Finding the Opportunity

Opportunity Zones are census tracts composed of economically distressed communities, according to criteria outlined in the Tax Cuts and Jobs Act. People and businesses can get federal tax breaks on capital gains they put into special funds that then invest in these designated zones. Opportunity Zones have been designated in all 50 states, the District of Columbia, and five U.S. territories, including hundreds across Illinois.

“Opportunity Zones are areas where residents need more employment opportunities and higher wages,” explains Charity Greene of the Illinois Department of Commerce & Economic Opportunity (IDCEO). “Receiving an Opportunity Zone designation puts these areas on the map for a national network of investors that may not have previously considered them.”

In Illinois, 1,305 qualifying census tracts were originally identified by the federal government. Illinois under then-Gov. Rauner was able to nominate 25 percent (327 total, of which 181 are in Cook County) of these tracts to be formally designated as Opportunity Zones, which were chosen based on their poverty rates, unemployment rates, total number of children in poverty, violent crime rates, and populations. The Federal Reserve Bank of Chicago also points out that a unique feature of the Opportunity Zones designation process is that tracts contiguous to low-income tracts are allowed to be designated, provided they meet other parameters; a state’s designated tracts may contain up to 5 percent non-low-income contiguous tracts.

IDCEO is working with the governor, the General Assembly, local partners, and the business community to encourage broad-based investment and growth in Illinois. “In the process, we strive to take advantage of any opportunity to leverage federal programs, like Opportunity Zones, as well as support from the nonprofit and private sectors,” Greene says. “Opportunity Zones are one important part of a larger coordinated effort to encourage investment in low-income communities.”

The Nuts and Bolts

The Opportunity Zones provide tax benefits to investors under certain conditions:

• Investors can defer tax on any prior capital gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or Dec. 31, 2026. If the QOF investment is held for longer than five years, there is a 10 percent exclusion of the deferred gain. If held for more than seven years, the 10 percent becomes 15 percent.

• If the investor holds the investment in the QOF for at least 10 years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.

A QOF is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is in a Qualified Opportunity Zone. Investors can get the tax benefits, even if they don’t live, work, or have a business in an Opportunity Zone. Investors just need to invest a recognized gain in a QOF and elect to defer the tax on that gain.

The best thing? These opportunities aren’t just for those with millions of dollars of capital gains to invest. Anyone with a business idea or who has recently made a return on their investments can take advantage of the program in any Opportunity Zone in the country. Investment options include retail stores, grocery stores, research facilities, hotels, restaurants, office buildings, and manufacturing and mixed-use developments. Creating a QOF is as simple as checking a box on IRS Form 8996 and submitting it to the IRS.

The Sleeper in the Tax Law

For a month or so after the passage of the TCJA in December 2017, Opportunity Zones hovered under the radar, playing second fiddle to all the news coverage on tax reform lowering the corporate tax rate.

Then, in January 2018, Dan Rahill, CPA, a tax partner with BDO in Chicago and a former chair of the Illinois CPA Society Board of Directors, received a phone call from a friend who sat on the board of a company and wondered if they could rezone in an Opportunity Zone. The new Opportunity Zone provisions had not received much attention to date, so Rahill took a closer look at this new tax provision. What he saw was intriguing.

“Up until then, none of us really saw the opportunity that was buried within the law,” Rahill says. “I started reading and discussing the possibilities with other advisors and potential investors. It became the topic of the day. Opportunity Zones could be the most talked about opportunity for investors to come out of the tax act for the next decade.”

Opportunity Zones are intended to release the private investment potential of over $6 trillion of captive capital gains into distressed communities to help jump-start growth, create jobs, and lift incomes. Treasury Secretary Steven Mnuchin has predicted that more than $100 billion dollars in private capital will be invested in Opportunity Zones.

“If that’s true, this could really have an impact,” Rahill says. “Hopefully the Opportunity Zones hit the mark of their intended purpose to drive investments into areas that need revitalization.” He offers the former Michael Reese Hospital site and the long vacant South Works on Chicago’s South Side as examples.

While there is now plenty of enthusiasm from investors, many delayed spending because of uncertainty about how the incentives would work. On April 17, 2019, the Treasury released the second tranche of regulatory guidance, providing answers to many questions, to help guide investors, fund managers, and others.

Full Speed Ahead

Rob Nowak, CPA, a partner in Baker Tilly’s Chicago office, says Opportunity Zones led to a new subset in the firm’s real estate practice. “Our clients and their investors recognized that a financial model for an Opportunity Zone deal is significantly different because of the tax benefits,” he says. “As a result, we’re gearing our services toward helping clients develop financial models that highlight the benefits Opportunity Zones bring to table.”

Nowak calls Opportunity Zones the most significant change in the real estate industry in 20 years. “The market is excited about it, and clients are excited about it,” he says, adding that clients aren’t looking only at projects in Illinois; Chicago clients are looking at Denver, Nashville, Phoenix, Cleveland, and Houston. “This isn’t just a local incentive.”

Chris Boehm, co-founder and managing partner of Cresset Partners, says from the outset, the economics of the Opportunity Zones program were not only compelling from an investor perspective, but also because of the underlying policy of making an impact where investment is needed to create growth. “We saw equal applicability in real estate development and operating businesses that were already running,” he says. “It’s a really interesting opportunity to raise and deploy capital into Opportunity Zones on behalf of our investors.”

Cresset Partners recently announced the completion of an investment in a multi-family development in Houston. The firm is exploring the range of opportunities for real estate and operating companies now that the second tranche of regulatory guidance has been released.

Community Impact

Even with all the apparent positives that Opportunity Zones offer, there are still concerns that local communities won’t benefit to the extent that has been promoted. At the last minute, specific reporting requirements were dropped from the bill. In April, the Treasury asked stakeholders to offer feedback about how to measure the community impact from Opportunity Zone investments.

“We also need some method of measurement as to the effectiveness of the law,” Rahill says. “How do we know that investment is being driven by Opportunity Zone development? The cities and states don’t know where funding is coming from. Was it because of the Opportunity Zone or not? The investment may have happened anyway.”

The lack of accountability at the local level is especially concerning to Mohammed Elahi, deputy director for the Cook County Bureau of Economic Development. “There is no requirement for investors to deal with the local government for any purpose aside from traditional permitting,” he says. “The second tranche of regulatory guidance didn’t cover reporting requirements or the role of local government or economic development representatives.”

Elahi suggests that if Opportunity Zones are truly meant to benefit the local communities, the qualified investment dollars wouldn’t be limited to only capital gains. “Why can’t ordinary investible dollars enjoy the same tax benefit of at least not paying taxes on future capital gains if the investments are held in an Opportunity Zone for 10 years?”

He also questions why the investment clock starts arbitrarily ticking in 2019 for a seven-year hold to enjoy a 15 percent reduction on an adjustable basis instead of when the actual investments are made. As of now, Opportunity Zones will sunset in 2047. “Why shouldn’t investors of future years be allowed to count the years from the date of their investment to enjoy the reduced adjustable basis of 10 percent and 15 percent for five-year and seven-year holds, respectively, along with deferment of taxes accordingly?” he asks. “The limitation on the source of qualified investible dollars to capital gains only will widen the gulf between the ‘haves’ and ‘have-nots’ because average people don’t have capital gains to invest. I might have 50 friends with $100,000 each. It’s just their savings, but why can’t they have the same tax benefit if they’re investing in an Opportunity Zone?”

Those are all fair questions. As is, will Opportunity Zones create jobs and revenue at the local level? Elahi isn’t sure. He uses the data storage boom as an example. Large amounts of real estate are needed to build data storage facilities. “They’re great for investors,” he says. “You’ll never run out of tenants. But even though a physical facility will pay property taxes to the towns, how many jobs will they create for those towns? Half a billion dollars will be spent to construct a data storage building, but it will only employ four or five people. That’s it. And in 10 years’ time, that building is gold [for the investors]. Yes, towns are happy because new property taxes will be paid, but it only creates four to five jobs. There’s no ‘community development’ test for this as the law is written now. Community development organizations are unhappy because there is no measurable and defined public benefit for Opportunity Zone investments.”

Elahi is hopeful a potential third tranche of proposed regulations will address these issues. In the interim, he says, “I’m not optimistic about the actual community benefit.” He has heard this same sentiment expressed by his peers in other states. “They’re also frustrated that accountability isn’t there.”

Nowak says Baker Tilly clients who have projects in process are hearing positive feedback from communities: “New investments and new jobs in a previously underserved area are well received.”

Boehm comments that Opportunity Zones aren’t a silver bullet. “They certainly won’t solve all the problems, but it’s a way of bringing progress and investment to under-invested areas, and that’s a positive thing. Opportunity Zones are one of a range of tools.”

Greene says the IDCEO is committed to ensuring that all residents have a chance to benefit from new investments and economic growth in Illinois. “We will continue to partner with local governments and economic development organizations throughout this process, and we will prioritize state investments that accomplish community goals and lead to sustainable growth.”

In early May, lawmakers in the U.S. House and Senate took a step toward addressing the lack of transparency, proposing requirements for information the Treasury would have to collect about Opportunity Zones.

Opportunities for CPAs

The body of law surrounding Opportunity Zones will continue to evolve, Nowak says. “There’s no fixed body of knowledge. It’s critically important for CPAs in any market to recognize that as the law continues to evolve, so must their understanding of the law.”

Rahill encourages CPAs to understand the rules, especially those business-focused guidelines released on April 17. “We should be prepared to discuss these opportunities with our clients, because in most cases, they haven’t identified the opportunity for themselves,” he says. “It’s an education process, and more importantly, a very viable investment alternative with significant tax benefits. It won’t apply to everyone, but you need to be able to recognize when it will apply to your clients and bring it to the table. Opportunity Zones are a very legitimate planning topic. Even if the fact pattern doesn’t end up being right for a client, now you’re having a tax and investment planning discussion, and that’s our goal.”

Family offices and high-net-worth individuals are sitting on trillions of unrealized capital gains, Rahill adds. “For them, this discussion is an absolute no brainer.”