US opportunity zone rules seek more capital in distressed areas

Bloomberg

The Trump administration released rules for a tax break designed to encourage economic development in distressed areas throughout the US by making it easier to invest in businesses and
real estate in low-income communities.
Wall Street banks, private equity firms, real estate developers and others have been eagerly awaiting the regulations, which the administration said will spur $100 billion of investment into the more than 8,700 areas designated as “opportunity zones” in the 2017 federal tax overhaul.
The 169-page proposal gives investors interested in these areas additional leeway and a more flexible timeline, a Treasury official told reporters. The rules also give investing funds a one-year grace period to sell assets and reinvest the proceeds, thus avoiding penalties intended to prevent funds from sitting on the cash.
The new Treasury regulations give funds six months from when they receive money to purchase assets that qualify for the special tax breaks. The rules also allow land and vacant buildings to be investments eligible for an opportunity zone fund, the Treasury official said.
The tax breaks — which allow some investments to appreciate without being subject to capital gains levies — are bringing development to marginalised areas, President Donald Trump said at a White House event to highlight the opportunity zones.
Investors previously have shied away from developing distressed areas, Trump said, but when they see tax rates “all the way down to a big, fat beautiful number of zero” they start “liking the location.”

WAITING FOR RULES
While there’s been a flood of interest in opportunity zones, many people have delayed investments to see if the rules make sense for the projects and businesses they have in mind. Skeptics of the provision will be looking for guardrails in the regulations to prevent investors from claiming a generous tax break for developments that do little to help the poor.
Under existing tax law, investors race to meet deadlines that require them to invest their capital gains income within 180 days of selling the stock or business.
The rules permit more flexibility to include more than one investment in a fund, the official said. Investors would like to create multi-asset funds to reduce the risk of a single bad project wiping out any return. The rules allow investors to get special tax treatment if they’ve held their stake in the fund for at least 10 years, even if the fund didn’t own the asset for a full decade, the official said.
Investors can also buy into a fund by directly purchasing an interest or buying another partner out.
TAX BREAKS
Investors claim the breaks by taking capital gains income they’ve already earned and deploying it in the distressed areas. The provision, part of the 2017 Republican tax overhaul, allows them to defer those tax bills until the end of 2026 and can reduce the total amount of tax they owe. The new investments in the opportunity zone can grow tax-free if investors hold them for at least a decade.
Several prominent investors, such as Goldman Sachs Group Inc., hedge fund EJF Capital LLC and New York-focused RXR Realty LLC, have already begun making investments in opportunity zones or are raising money to do so. These funds are rushing to invest in some urban areas most likely to produce large returns.

CRITICS’ CONCERNS
Some critics argue the law is written so loosely it could become a handout to the wealthy, juicing returns on projects they would have pursued anyway. Others say that the bulk of investment could go to zones in places like Brooklyn and Portland, Oregon, that have little trouble attracting investment.
The most recent rules follow regulations from October to instruct investors on how to qualify for the tax breaks.
The regulations also address a problem flagged by many investors looking to create startup businesses: the requirement that businesses generate at least half their gross income within their opportunity zone. That works for an apartment building or a grocery store, but would be a disaster for a business hoping to manufacture a product to be sold widely, or provide services online.
The rules give funds three different ways to prove that they are conducting enough business from within the zone. Treasury will allow businesses to qualify if at least 50 percent of the hours the employees work are within the zone, as long as it performs at least half of its services within the area, or if there are significant management and operational functions present. Businesses can also appeal their specific case.
Fifty percent of the sales do not have to come from within the geographic zone, the official said.