This article was originally published in Tax Analyst, December 2019.
The impact of the federal enactment of qualified Opportunity Zones through the Tax Cuts and Jobs Act continues to resonate among state and federal tax credits and incentives nearly two years later. The rush to take advantage of the new program has had a side effect: Taxpayers may be overlooking benefits provided by older, more established credits and incentives in their drive to invest in Opportunity Zones. The investment incentives provided by the program are appealing, but should only be a part of the overall strategy for taxpayers seeking the maximum bang for their investment buck.
Enacted as part of the TCJA[1], sections 1400Z-1 and 1400Z-2 contain the provisions of the federal qualified Opportunity Zone programs. Opportunity Zones are economically distressed communities as designated by each respective state. The exception to this is Puerto Rico, where each tract that is a low-income community is automatically within a qualified Opportunity Zone.
Taxpayers take advantage of the benefits by reinvesting otherwise-taxable capital gain in a qualified opportunity fund that has at least 90% of its assets in qualified Opportunity Zone property. The reinvestment must take place within 180 days of the date that the sale or exchange of the property would have been taxable. The gain is deferred until the earlier of Dec. 31, 2026, or the date when the new investment is sold or exchanged, with a percentage increase in basis allowed that increases the longer the taxpayer holds the investment. If the taxpayer retains the investment for at least 10 years, it can elect to make the basis equal to the fair market value when it sells or exchanges the investment.
State response to opportunity zones
Because their statutes automatically incorporated the federal provisions, states that adopted blanket rolling conformity provisions generally did not need to enact legislation allowing taxpayers to realize Opportunity Zone benefits for state tax purposes. However, as with most federal tax code provisions, even broad state conformity may be selective to only specific sections, including the capital gain deferral in section 1400Z-2.
Rather than automatically conforming to the code on a rolling basis, other states conform to it as of a specific date — thus requiring that legislation be enacted each year to update the conformity date in order to incorporate recent federal changes. Most states that require legislation to conform have enacted measures complying with the code as of a specific date post-TCJA. There are notable exceptions, however. California[2] has selectively conformed to a number of TCJA provisions and does not conform to the tax treatment of capital gains as set out in the OZ program.[3] And following the repeal of its provision specifying that sections 1400Z-1 and 1400Z-2 were not operative, Hawaii allows the deferral, but only for tax years beginning on or after Jan. 1, 2019.[4]
Other states require the specific adoption of each provision of the code for them to be effective. Arkansas enacted S.B. 196 in February, fully implementing Opportunity Zone benefits retroactively for tax years beginning in 2018.[5] Conversely, Mississippi also requires the specific adoption of provisions of the code, but has not enacted legislation adopting the Opportunity Zones.[6]
Beyond the incorporation of the deferral into their computation of taxable income, a number of states have enacted bills that seek to expand or augment tax benefits based on taxpayers’ participation in the federal program. These state programs are not limited to Opportunity Zone investors — they can also benefit operating businesses that happen to be located or otherwise expanding within the Opportunity Zone.
On June 21 Connecticut enacted S.B. 570, which requires the state to prioritize projects located in federal Opportunity Zones among applications for historic rehabilitation tax credits and urban and industrial site reinvestment credits.[7] The bill also requires the state’s commissioner of economic and community development to host public educational events to advertise the Opportunity Zones as investment opportunities, as well as study how Connecticut can incentivize investment in the zones. S.B. 570 demonstrates that the state is looking for strategies to leverage the lure of the federal zones to attract investors in Connecticut.
In a similar vein, on April 30 Maryland enacted S.B. 581,[8] which establishes an Opportunity Zone Enhancement Program and allows the comptroller to administer larger credits for businesses in the zones. Among the credits enhanced by this program are the Biotechnology Investment Incentive, the Cybersecurity Investment Incentive, and the More Jobs for Marylanders Incentives. Similar to the Connecticut provisions, the comptroller must publish information on the Opportunity Zones on its websites, as well as information reported by any qualified opportunity fund receiving enhanced tax credits. The benefits of participation in these programs in Opportunity Zones can be quite large, as the level 2 Opportunity Zone enhancement for investment in a biotechnology company is 75% of the investment up to $750,000, and 50% of investment in a cybersecurity company up to $500,000. Maryland is clearly looking to attract investors in its industries of choice by offering more state tax incentives.
West Virginia has taken a slightly different, if more expansive, tack in its approach enacted in H.B. 113.[9] The bill creates a subtraction for income derived from federal qualified Opportunity Zones for both individual and corporate investors beginning Jan. 1, 2019. The subtraction is allowed for a 10-year period and is available to newly registered businesses in Opportunity Zones until 2024. Businesses that qualify before the 2024 cutoff will retain the benefit until the end of their 10-year period. This more expansive definition allows a wider variety of taxpayers to take advantage of the federal program at the state level.
These are just three examples of states seeking to drive investment by attaching their programs to the federal provisions either by augmenting existing incentives or adding new ones.
Investors may be missing the bigger picture
Many taxpayers making new investments are looking to take advantage of the Opportunity Zone incentives. However, a side effect of the fervor over these programs has been investors and project developers overlooking more established incentives at the federal, state, and local levels that have been available for some time. These programs’ benefits may overlap with the Opportunity Zone incentives, and investors should avoid tunnel vision in their approach to taking advantage of investment prospects.
The federal New Markets Tax Credit (NMTC) is one program that has a similar intent to the Opportunity Zones.[10] The goal of the program is to attract investment in economically underdeveloped census tracts. But rather than providing a deferral of capital gains for reinvestment in these areas and projects, the NMTC offers a tax credit for investors and a forgivable loan to businesses operating within the qualifying area. Investors make an investment in a community development entity in exchange for a tax credit equal to 39% of the allocation of the project. The community development entity then uses the funds generated from the sale of the tax credit to make forgivable loans in a business that operates within a qualifying distressed census tract.
Taxpayers need to be aware that the low income communities targeted for investment by the NMTC often overlap with Opportunity Zones. Unlike the Opportunity Zone program benefits, a business that is growing and expanding in a NMTC location can access the NMTC incentives as soon as it incurs project costs. The full amount of the loan can be drawn down as quickly as the company completes its agreed-upon investment. After seven years, assuming the company has maintained agreed-upon job and investment commitments, the loan is forgiven.
Investors should consider placing their money in projects located in both Opportunity Zones and NMTC-eligible locations. By doing so, benefits can likely be realized sooner through the NMTC program, with the potential Opportunity Zone benefit coming at a later date.
Additional opportunities for synergy between incentives are not only available federally, since many states have enterprise zone or similar programs designed to encourage investment in specific localities. These credits and incentives may be structured around different metrics, but it may be possible for investors to take advantage of them at every level.
For example, Louisiana provides enterprise zone incentives giving the option of one of two benefits for taxpayers: either a rebate on sales tax paid for qualifying materials, machinery, furniture, and equipment; or a refundable investment tax credit of 1.5% of the capital investment in the project.[11] The credit seeks to drive investment in the creation of new businesses or expansion of existing businesses in underserved areas. The business must create a minimum of five jobs within 24 months or increase its statewide workforce by 10% in the first 12 months, and at least 50% of those new jobs must be for individuals within the targeted groups: residents of the enterprise zone, people receiving approved forms of public assistance, people lacking basic skills, or people unemployable by traditional standards. The Illinois enterprise zone investment credit is another well-established state program that taxpayers could take advantage of while seeking to make qualified Opportunity Zone investments.[12] The program offers a credit equal to 0.5% of the basis of qualified property placed in service within an enterprise zone or a River Edge Redevelopment Zone. Unlike the Louisiana credit, it is nonrefundable, but investors can carry it forward up to five tax years.
Other credits are available to drive business growth in distressed areas that are not measured by the investment in the business, but rather by the number of new jobs created. For example, Georgia provides credits for entities that create new jobs in less-developed counties and census tracts.[13] These credits organize the counties in a tiered system, with Georgia’s most distressed areas being granted a higher credit amount and the ability to use the credit against payroll taxes.[14]
In all of these cases, states lay out the zones for their programs. Taxpayers looking to invest to take advantage of the federal Opportunity Zones should be aware that by strategically placing their investments, they may gain benefits at multiple levels in situations in which these zones intersect.
Real estate incentives
Beyond tax benefits conferred by investment in underdeveloped areas at the state and federal levels, local real estate incentives are also available to businesses. Many localities seek to draw investment in their areas that may coincide with programs that offer tax incentives, or even be more lucrative.
For example, cities and counties may offer tax increment financing to investors seeking to develop within their jurisdictions. These financing programs subsidize development, effectively reimbursing businesses for a percentage of their investment. Generally, the programs reinvest the excess of property and sales taxes generated by the new investment into development or redevelopment projects. For example, Houston City Council has created Tax Increment Reinvestment Zones, [15] in which the city helps finance the cost of redevelopment in targeted areas, and any taxes attributable to the improvements go to finance public improvements in the zones. Investors or developers seeking to develop property in Opportunity Zones should consider that these types of incremental financing strategies are available throughout the country.
If investors are unsure about placing significant funds into development projects, payment in lieu of taxation (PILOT) programs may be another mechanism to increase return on investment by lowering property or local taxes. These programs provide a municipality a mechanism to remove property from its tax rolls —thereby allowing the operating company to reduce its tax burden. For example, Memphis has a PILOT program intended to draw interest in jobs and economic growth.[16] Companies participating in the program receive a 75% property tax reduction in exchange for relocating to property that otherwise was not producing any tax revenue. The benefits are generally designed to expire, but the initial reduction in property tax is a strong incentive to choose one of these locations.
If localities are particularly eager to drive investment, they may also offer in-kind contributions for investors. In these scenarios the locality offers to include land, development of infrastructure, or other assistance or property to aid in the development projects. These contributions can be very valuable, so investors should consider building strong relationships with localities to gain them.
An expansive approach
While taxpayers may be focused on availing themselves of the benefits of the qualified Opportunity Zones, they should not lose sight of the bigger picture of tax credits and incentives. Many well-established programs provide lucrative benefits to investors seeking to strategically place capital in new endeavors, and these often overlap with the Opportunity Zone incentives. Taxpayers should consider a holistic approach in their investment planning to ensure that they are receiving the maximum benefit from the wide variety of available incentives.
