Editor's Note: Join the National Trust's Government Relations team on their webinar where they will take a deeper dive into the tax bill and talk about the the Opportunity Zone Program described below. The webinar takes place on Thurs., March 1, 2:00–3:00 p.m. ET. Register here.
A little-noticed provision tucked into the monumental tax reform act that Congress passed at the end of 2017 has the potential to deliver big benefits for historic preservation—but only if advocates act fast. Preservationists have until March 21 to convince their governors to include underinvested historic neighborhoods on the lists of areas that will be eligible for a new tax incentive sometimes known as the Opportunity Zone Program.
The new program was added to H.R. 1 (also known as the Tax Cuts and Jobs Act) through an amendment proposed by Sen. Tim Scott, R-S.C., that was adopted with bipartisan support. It creates so-called Qualified Opportunity Zones (QOZs), which offer significant tax breaks to investors seeking to defer or abate their capital gains taxes. Eligible investments include those in new buildings and the substantial improvement of existing ones—including historic buildings—as well as other companies and projects. Corporations, real estate companies, and individuals looking to reduce their capital gains tax liabilities are all possible investors.
The benefits for investors are potentially huge. Taxpayers can defer short or long-term capital gains by reinvesting the capital gain portion in a “qualified opportunity fund” within 180 days. That fund must, in turn, invest the proceeds in “qualified opportunity zone property.” If the investment remains in the fund for five years, the taxpayer will receive a step-up in tax basis equal to 10 percent of the original gain. After seven years the investment basis increases by an additional 5 percent. If the investment is held for 10 years or longer, the investor’s basis in its interest at the time of sale or exchange will equal the interest’s “fair market value,” which means that post-acquisition appreciation in qualified opportunity funds is essentially exempt from taxation. While these benefits may sound esoteric, anyone who runs numbers on real estate investments will immediately see their potential.
QOZs are defined by census tracts, but which are eligible? For starters, the bulk of the tracts have to meet the definition of a “low-income community” under Section 45D of the Internal Revenue Code. This is also used to determine eligibility for New Markets Tax Credits, another federal tax incentive often used to finance historic rehabilitation. But not all low-income census tracts can be QOZs. To be a QOZ, a tract must be nominated by the governor of the state or territory (or the mayor, in the case of the District of Columbia), and the law provides that the number of nominated tracts may not exceed 25 percent of the total number of low-income tracts in a jurisdiction.
Take, for example, a state with 500 low-income census tracts. That state’s governor may nominate no more than 125 of them to be QOZs. (A special provision allows states with fewer than 100 low-income tracts to have 25 QOZs.) Up to 5 percent of the total tracts nominated can be non-low-income tracts, as long as (1) they are each contiguous to at least one low-income tract and (2) the median family income in a non-low-income tract does not exceed 125 percent of that in the contiguous low-income tract. In addition, a provision of the Bipartisan Budget Act of 2018, enacted on February 9, automatically designates every low-income tract in Puerto Rico a QOZ.
But the states and territories (other than Puerto Rico) face a major catch: the new law gives governors only 90 days from the date of enactment to nominate tracts for QOZ designation. That’s right: the law was enacted on December 22, 2017, which mean states must act by March 21. States can seek a 30-day extension of this deadline, but either way, this one-time opportunity disappears soon. Understandably, many states are only now catching up to this program. In many places the process will likely be political and involve competing interests advocating for different approaches and census tracts. A major backer of the QOZ program, the Economic Innovation Group, has developed suggested guidance for governors on how to select QOZs.
Many historic resources in need of investment are located in tracts eligible for QOZ designation. Securing the nomination of these tracts to the QOZ list can help unlock needed capital for these communities and spur revitalization. Combining QOZ benefits with historic tax credits (which happily were retained in the tax reform legislation) could make preservation projects in QOZs some of the most advantaged investments around. Ditto for pairing them with the Low-Income Housing Tax Credit and the New Markets Tax Credit, strategies that—along with inclusionary zoning, land banking, and other techniques—have the potential to distribute any resulting development gains more equitably.
So how can preservationists make the case for historic areas? In many states, it may not be immediately clear which office is charged with handling the QOZ nomination process. The governor’s office is a good place to start, and state economic development and community affairs offices may also be able to help.
Next, advocates will need to prepare a list of suggested census tracts. Most preservationists know which areas have historic resources in need of investment, but they’ll also need to confirm whether those areas are in (or adjacent to) eligible census tracts. Fortunately, the U.S. Treasury Department has provided a database for mapping addresses. It isn’t the only way to determine eligibility, but it’s a great place to start. And, on February 8, the IRS published a short guidance that answers a number of technical questions. Also, national nonprofit intermediary Enterprise has created additional mapping tools and resources.
Advocates should also prepare explanations for why the areas they’re putting forward deserve to be included. While governors were ultimately allowed an enormous amount of flexibility, legislative histories prepared for earlier versions of the law advised governors to give particular consideration to areas that (1) are currently the focus of mutually reinforcing state, local, or private economic development initiatives to attract investment and foster startup activity; (2) have demonstrated success in geographically targeted development programs in the past—e.g., Promise Zones, areas eligible for New Market Tax Credits, Empowerment Zones, or Renewal Communities; and (3) have recently experienced significant layoffs due to business closures or relocations. While this list is not comprehensive, it can help advocates build a successful case.
Uncertainties remain about whether H.R. 1 will be good for America’s historic neighborhoods. For example, some projections suggest that the new law will increase income inequality, which would imperil preservationists’ efforts to build more inclusive communities. Pursuing QOZ status for historic resources may not change the broad impacts of this legislation (whatever those turn out to be), but it can make a difference in certain neighborhoods—but only if we act now!
Andrew Potts practices historic preservation law at Nixon Peabody LLP in Washington, D.C.