By Monica C. Meinert
Thousands of communities throughout the U.S. could soon see an influx of capital and investment, thanks to a new federal tax incentive program included in the 2017 tax reform law. The Opportunity Zones initiative targets more than 8,700 communities—the vast majority of which are low-income—in all 50 states, the District of Columbia and five U.S. territories.
The thinking behind the program is to drive investment capital into communities that need it by allowing taxpayers to invest capital gains into qualified “opportunity funds.” By making such an investment, the taxpayer is able to defer capital gains tax through 2026, or whenever the investment in a qualified opportunity fund is sold or exchanged, whichever comes first.
If the investment is held for longer than five years, taxpayers will realize a 10 percent exclusion of their deferred gain; if it is held for more than seven years, an additional five percent is excluded. In addition, assuming the investment is held 10 years, any additional gain that the taxpayer realizes on the investment itself is not taxed.
“If an investor has capital gains and a longer term investment view, this is a great opportunity to at a minimum defer recognition of tax and if appropriate holding periods are met, an opportunity to permanently avoid paying some percentage of the tax on gains,” notes ABA VP John Kinsella.
Due to special tax rules, many banks do not have capital gain income and may have limited opportunity to invest themselves. That said, for bankers that have an Opportunity Zone in their market, the program could mean a greater influx of capital into these areas that could be particularly beneficial in rural areas where low land values have made lending a challenge. “It’s very hard to build in some of these areas—it costs more to build than [the project is] worth when it’s done. This will help bridge that gap,” says Roger Shumway, EVP and chief credit officer at Bank of Utah in Ogden, Utah. “From a deal perspective, bankers might see a lot more cash down than we’re used to, and that might make the numbers work.”
In addition, banks may now have more capital available to lend, thanks to recent changes from the S. 2155 regulatory reform law. “Under S. 2155, regulators are only assigning a heightened risk weight to high volatility commercial real estate exposures if they meet the definition of an HVCRE ADC loan,” explains ABA VP Sharon Whitaker. “This will help free up capital that banks can direct back into their local markets.”
The Opportunity Zones incentive is still evolving —when this article went to press, the Treasury and IRS were still working to propose and then finalize additional regulations related to the program. But Shumway notes that “I think the big impulse is yet to come.” In his market, he says he’s already seeing “more California [investor] groups coming in and looking at different types of projects.”
And it’s not just happening in Utah: CoStar—a commercial real estate consulting firm—earlier this year said that sales of commercial properties in Opportunity Zones nationwide have already risen 12.4 percent year on year, indicating that there is already increasing demand in these areas.
At Bank of Utah, Shumway says he’s taken the time to discuss the program with his lenders, and the bank has already begun doing outreach to local developers to ensure that if they establish qualified opportunity funds, the bank is in a position to make the loan. “It’s an educational thing right now to get the word out,” he adds.