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Get In the Zone: Opportunity Zones Expected to Present Lucrative Opportunities

William Saya, CPA
10.25.2018 | Berdon Industry Insights

The Opportunity Zone Program embedded within the federal Tax Cuts and Jobs Act of 2017 has created a significant buzz, which continues to reverberate throughout the real estate community.

According to Bruce Stachenfeld, a founding partner at the real estate law firm Duval & Stachenfeld LLP, the new program has the potential to be “the biggest thing that has hit the real estate world, maybe ever.” A Forbes headline calls it “The Most Unbelievable Tax Break Ever.” While this headline may seem like hyperbole to some, when taking a balanced view of the content of the law, it is indisputable that the interest and excitement over the program in the real estate industry remains palpable.

The program allows taxpayers to defer and exclude portions of capital gains that are reinvested in opportunity zones. Investors in opportunity zones can defer tax on any prior gains associated with sales of real estate and non-real estate assets until the earlier of the date on which an investment is sold or exchanged, or December 31, 2026, so long as the gain is reinvested in a Qualified Opportunity Fund. Such a fund must keep 90% of its capital in the designated opportunity zones among other requirements. Second, investments of deferred gains in opportunity zones are eligible for capital gains tax reductions of 10% if held for at least five years and 15% if held for at least seven years. Still more, according to the Act, if the investor holds the investment in the opportunity fund for at least ten years, the gain on the appreciation of the opportunity zone investment is excluded from tax. For additional information on the current state of the law, read Qualified Opportunity Zones—Invest in Low Income Communities, released on September 26, 2018.

The aim of the program is to channel investments to help in the redevelopment of many of the country’s low income communities. By providing a tax-incentive to companies and high-net worth individuals, the new program seeks to put the estimated $6.1 trillion in unrealized capital gains in stocks and funds that currently sits on the sidelines back to work.

At a meeting with Treasury Secretary Steven Mnuchin on September 6, 2018, the U.S. Conference of Mayors expressed their bipartisan support for the initiative and impressed upon the Secretary the importance of timely and effective IRS guidance to implement the opportunity zone provisions. Columbia, South Carolina mayor Steve Benjamin, chairman of the U.S. Conference of Mayors, said that he and his fellow mayors are “eager to see the regulations come out and to start seeing some of this capital flow into our communities.” New Jersey senator Cory Booker hailed the creation of the new opportunity zones, calling them “domestic emerging markets.”

Earlier this year, the US Treasury and IRS announced the first round of designated opportunity zones, which include a number of designations within the NY metro market. In Connecticut, zones have been established in New Haven, Fairfield, and Litchfield; in New Jersey, zones have been created in Bergen, Essex, Hudson, Middlesex, Union, and Passaic counties; and New Yorkers will benefit from zones in Manhattan, the Bronx, Brooklyn, Nassau, Suffolk, and Westchester. Thus far, the US Treasury has authorized the creation of 8,700 opportunity zones. A full list of zones by state can be accessed from the US Treasury at: https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx.

The benefits to the NY Metro and national real estate markets are expected to be significant. Thanks to the promise of deferred, and potentially exempted, capital gains taxes, a spate of re-development in low-income areas is anticipated. According to data firm Real Capital Analytics1 , sales of development sites in opportunity zones nationwide have spiked 80% in the first three quarters of 2018, compared with the same period last year. In addition, we are already seeing real estate investment firms and financial institutions racing to raise billions in order to capitalize on the new tax incentives. Real estate investment firms such as Shorewood, RXR Realty, and Youngwoo & Associates are already raising capital in order to invest in the new zones. Michael Maturo, RXR’s president and CFO, recently told the Commercial Observer that he sees a “big opportunity” in the program. “It makes a lot of sense for us to explore opportunities to take advantage of this tax program,” said Maturo. In August, RXR launched a $500 million fund in order to capitalize on the new program. For its part, Shorewood has reportedly launched a $250 million opportunity zone fund.

Financial institutions are also seeing great potential in the new program. Goldman Sachs has created an opportunity fund with an eye toward investment in the NYC metro market, while the $6.9 billion hedge fund EJF Capital is looking to invest in opportunity zones nationally.

This optimism in the markets has been somewhat tempered by the delay in more definitive guidance from the Treasury Department, which has recently begun to be released. Another concern is that the allure of the new law may spur market rate developments in areas, rather than provide affordable housing, which is in short supply and the primary driver of this incentive.

For the latest developments on opportunity zones and a detailed analysis of the new guidance issued by the Treasury Department, connect with a Berdon professional and keep current with the latest insights from Berdon’s Real Estate and Tax Practices. You can reach me at 212.331.7588 | bsaya@berdonllp.com

Berdon LLP New York Accountants

1 Developers Look to Hit Tax-Break “Jackpot” in Opportunity Zones, The Wall Street Journal, October 23, 2018