Pros and cons of “Opportunity Zones”

Two years in, here’s what you should know, including how to best use them

After two years on the books, we’ve started seeing the pros and cons of “Opportunity Zones” emerge.

The program was introduced as part of 2018 tax reform legislation, providing potential tax benefits for those investing in designated distressed communities in the United States. Those investments could go toward existing businesses, development of a new business, or real estate, and could allow for growth of that investment tax free for years, potentially increasing annualizing returns.

On June 4 of this year, the IRS issued notice about additional coronavirus relief for those investing in Opportunity Zones and Opportunity Zone funds. So after all this time, and with these new relief efforts in the mix, what are the pros and cons of this investment opportunity? And how can an investor best use them? Let’s take a look.

Positives and negatives to this tax incentive

Pros of Opportunity Zones

In the past two years, we’ve come to see many potential benefits to Opportunity Zones.

• Opportunity Zones have a chance of benefitting more low-income communities than past programs. We now have more than 8,700 designated Opportunity Zones throughout the United States, far surpassing the number of eligible distressed communities included in past investment incentive programs.
• Investors have incentive to develop distressed communities that might not otherwise catch the eye of investors. That’s important, as evidenced by the U.S average poverty rate, which is nearly 31% in Opportunity Zones and 12% nationwide.
• Guidelines, known as Opportunity Zone Frameworks, increase the likelihood the program will deliver positive social outcomes — the primary goal of designating and developing these zones in the first place.

Cons of Opportunity Zones

Still, there’s room for improvement.

• Opportunity Zone investors are not required to work with local residents or community leaders in the planning process. That can create a disconnect between the realities of the communities and those investing in them. While investors obviously want to see a return on their investment, some development can simply drive up the cost of living in a neighborhood, making it harder for low-income residents to maintain their affordable housing.
• Following Opportunity Zone Frameworks isn’t mandated. So while an investor will look to the potential for the greatest ROI, such as with a luxury hotel, construction of luxury businesses are unlikely to best serve those community members in the way the program could. Mandatory guidelines could help ensure a greater focus on the needs of residents, such as grocery stores, transportation and affordable housing.
• States approached the Opportunity Zone selection differently, with some focusing on the communities of greatest need, and others focusing on potential investment returns for developers. As a result, some communities designated as Opportunity Zones are actually better off than other nearby neighborhoods in need of development. In some cases, states chose areas already showing signs of recovery and gentrification.

How best to use Opportunity Zones

Deciding how to invest in Opportunity Zones for greatest benefit depends on your approach. “Impact washing” is a concern, certainly we can see evidence that it’s a valid one with luxury hotels and condos moving into these low-income areas. If your desire is solely to utilize these tax tools to turn a profit, that’s one thing. But if your intention is to create meaningful social impact in distressed communities, it’s vital to think about where those profits flow.

Consider how much of that profit is returned to the community, not just in limited planned giving, but longer-term economic influencers. This may mean framing your decisions in terms of living wage or (better) jobs created, and training for those who live in the area to address any skills gap. In the end, what constitutes best use of Opportunity Zones is up to you; the potential to both reap the benefits of tax incentives and impact positive social change is within reach.

The latest relief for investors into Opportunity Zones

The June 4th IRS notice was regarded as big news in the Opportunity Zone world, as it extended relief to investors affected by the pandemic. That includes a previous 180-day investment deadline (for investment periods ending between April 1 and December 31 of this year) being extended until the end of 2020. Compliance deadlines under this notice are granted additional relief as well. Contact your tax advisor for additional information about how this may impact your Opportunity Zone investment.