Forum Webinar: Opportunity Zones and the Preservation Community

By Forum Online posted 01-30-2019 16:55

  

Last week the National Trust for Historic Preservation’s Government Relations department, the National Trust Community Investment Corporation’s (NTCIC), and Main Street America cohosted Preservation Leadership Forum’s most recent Forum Webinar, which explored both the opportunities and risks that Opportunity Zones, a new federal incentive, present for preservation. The webinar was among most successful hosted by the National Trust to date, with 730 registrants, which points to the preservation community’s interest in Opportunity Zones.

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One frustration with Opportunity Zones has been that their boundaries sometimes miss key revitalization projects.The former Anthony Overton Elementary School, one of 49 elementary schools shuttered by Chicago Public Schools in 2013, is a 1963 Chicago Landmark by Perkins + Will. Residents of the Bronzeville neighborhood see it as an important community landmark as well. Its reuse as a small business incubator by developer Ghian Foreman has languished due to financing challenges. The Opportunity Zone Program could have enticed investors, but the zone ends across the street. | Credit: Landmarks Illinois

Congress has created this broad tax incentive to encourage investors to deploy private wealth held in appreciated assets as long-term equity investments in economically distressed neighborhoods. Unfortunately, experience has taught preservationists that the gap between policy intentions and consequences can be stunningly wide; we still carry the cultural memory of Urban Renewal with us, and our communities still bear its scars. Of course, Opportunity Zones don’t encourage demolition like Urban Renewal did, but nor does the incentive have any provisions to discourage demolition. Like any other tool, Opportunity Zones can be misused.

Ultimately, the impact of Opportunity Zones on older and historic neighborhoods and communities will depend on a robust response from preservationists. Given the lack of guardrails and community benefit standards, it is essential that Qualified Opportunity Fund (QOF) investments be guided by protections and incentives at the state and local levels. Fortunately, a wide range of tools at the local level can ensure that projects backed by QOF investments respond to local needs and priorities.

Jim Igoe, executive director of Preservation Massachusetts, moderated the webinar. Five speakers offered a wealth of knowledge and a wide range of perspectives on Opportunity Zones, while also acknowledging that there are as many questions as answers about a policy development that could have profound effects on many of the nation’s most economically disadvantaged communities:

  • Forrest David Milder of Nixon Peabody provided an overview of Opportunity Zones, highlighting how the incentive fundamentally differs from the tax credit programs with which most of us are familiar.
  • Alex Flachsbart, founder and CEO of Opportunity Alabama, and Bonnie McDonald, president and CEO of Landmarks Illinois offered two distinct statewide perspectives. Flachsbart described Opportunity Alabama’s ambitious efforts to develop a statewide ecosystem to bring together investors, communities, institutional supporters, and potential community development projects, while McDonald discussed Landmark Illinois’ exploration of its role in positioning preservation projects for QOF support.
  • Merrill Hoopengardner, president of NTCIC, discussed how NTCIC is working on ensuring that New Markets Tax Credits (NMTC) and historic tax credits can complement the new incentive. This would not only make reuse projects more competitive but also introduce those existing programs’ regulatory guardrails to projects that would otherwise enjoy no federal protections of historic properties.
  • Anthony Veerkamp, director of policy development for the National Trust’s Research & Policy Lab, offered some closing thoughts about just what a gamechanger Opportunity Zones are to federal policy regarding community development.

A recording of the webinar is available. Presenters could not get to all the questions during the webinar, so we are answering the remainder (lightly edited for clarity) here.

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The Opportunity Zone ecosystem concept is at the heart of Opportunity Alabama’s state implementation strategy. | Credit: Courtesy of Alex Flachsbart

Are Opportunity Zone investors shy of nonprofit or non-income-producing properties? Is the tax benefit itself enough for investors?

Remember that the fundamental principle of Opportunity Zone investing is reducing the tax liability associated with selling off an old investment and making a new one; any QOF driven exclusively by financial return would not be interested in projects that don’t generate such a return. This doesn’t mean that there won’t be social impact investing, but it will depend on the particular investor. And there is still room for the development of social impact QOFs like those being supported by Kresge & Rockefeller.

Can an investor use funds not from capital gains to invest in a QOF? If they do, will that investment's real estate gains after 10 years be non-taxable?

It is possible to invest in a QOF with non-capital gain funds, but the investor won’t get any of the special tax breaks for that portion of the investment, and they will have the extra burden of keeping track of the respective shares of the investment.

Are there any limitations on the use of the property—e.g., commercial, office, retail, residential? Are any—or all—of these uses allowed?

There is a difference between assets held directly by a QOF and assets held by subsidiary entities. Assets held directly have very few restrictions. But, as illustrated in the webinar, it can be very difficult to pass the 90 percent test. Assets held by subsidiary entities face two potential limitations: (1) certain businesses—golf courses, country clubs, tanning parlors, hot tub facilities, massage facilities, racing and gambling facilities, and liquor stores—are not allowed, and (2) they must be engaged in an “active trade or business.” No one is certain how this will apply to leasing businesses, and the IRS has reserved setting rules on this in the proposed regulations. For example, it is possible that triple net leases will not be considered active. It is worth noting that many of the comment letters sent to the IRS requested something simple—e.g., that any business that generates revenue within three years of the investment be considered “active.” We’re awaiting guidance on this point.

Can the building that is to be renovated be owned by the city? Or must the QOF (or an LLC) purchase the building?

If we are talking about investing in a building, then either (1) the building is to be owned by the QOF (or a subsidiary entity) or (2) the building could be owned by the city and leased to the QOF or subsidiary entity for a very long term—75 years or longer. If the QOF owns a business that operates in a building, but not the real estate, then that building being owned by the city would be acceptable.

Could a QOF invest in an existing project for properties that need additional investment, but the ownership of which has been in place for several years? Can an existing owner be an investor in the QOF (or an LLC)

In general, property must be transferred to a new owner after 2017, and that owner must be no more than 20 percent related to the former owner. It is possible that the IRS will allow a building that does not meet that standard to qualify for favorable treatment if it is owned by a subsidiary entity and its value is less than the 30 percent “bad assets” permitted for subsidiary entities. This is another point that would benefit from clarification by the IRS.

Will a project need to conduct a securities offering to admit the QOF as a member in the owner LLC? What if the QOF isn't an accredited investor?

While the term “fund” as used in the Internal Revenue Code does not mean that the securities laws necessarily apply to a QOF investment, this is nonetheless a securities law question. Answering it would require specialized expertise and depend on the particular facts of each case.

Are there platforms to market Opportunity Zone real estate projects in the pipeline?

There are currently only a few “clearinghouses” for Opportunity Zone investing. During the webinar, McDonald and Flachsbart described the prospectus template developed at Drexel U. Also, the National Council of State Housing Agencies has compiled the Opportunity Zone Fund Directory, a list of more than 75 funds that are looking to make investments.

Is there a deadline to invest funds to take advantage of Opportunity Zones?

The investment must be made before June 29, 2027. Note that the deferred tax liability from the original gain accrues on December 31, 2026, so by waiting, an investor may lose one of the tax breaks—the ability to get the 10 percent and 5 percent step-ups—because the investment will no longer take place five or seven years before that date.

Absent historic district protections, could Opportunity Zones be a gentrification tool for investors to the detriment of the legacy community?

Communities could deploy a wide range of protections beyond historic district designations to limit the scope of displacement—like inclusionary zoning, tenant protections, or community land trusts. But as QOFs chase projects with the highest return, they will be drawn to those Opportunity Zones that are already gentrifying, leading to a snowball effect, as you can see from this list of the top 10 Opportunity Zones in the country. For more, see “Will Opportunity Zones help distressed residents or be a tax cut for gentrification?” and “How Opportunity Zones Benefit Investors and Promote Displacement.”

Must the cost of renovations be more than was paid for the building?

Yes. A property is deemed “substantially improved” if, during any 30-month period beginning after it is acquired, additions to basis with respect to the property are greater than 100 percent of the adjusted basis of such property at the beginning of that 30-month period. Land is excluded from the adjusted basis calculations. For a rehab project, the substantial improvement criterion means that renovation costs must be greater than the acquisition price.

The local Opportunity Zone boundary line goes down the center of our Main Street—one side is in, one side out. Can this be revised?

The Opportunity Zones are final, and short of an amendment to the law by Congress, nothing can be done to revise them.

Does the Opportunity Zone program favor development of vacant property rather than renovation of existing buildings? Most Opportunity Zones are probably fully built out.

The vast majority of Opportunity Zones are not fully built out—keep in mind that a big chunk of them are rural. That aside, the major difference between new construction and rehabilitation is the substantial improvement test that requires capital expenditures equal to the basis of used property (not including the basis in land). This requirement could make the development of vacant property easier.

Some investments do not work out. How is a "future loss" in the basis after 10 years handled?

First, when it comes to accruing the tax liability in December 2026, the rules provide that the gain recognized at that time is based on the lesser of the gain deferred or the value of the investment at that time. If the investment declines in value, the tax bill will be reduced. Second, the step-up to fair market value is elective. If a fund investor sells their interest at a loss, this will generally be a capital loss and be subject to limitations accordingly.

The Opportunity Zones are probably mostly in depressed areas. How can investors ensure that they make a profit?

By definition, Opportunity Zones are in “low-income communities,” as defined in the context of the NMTC. However, that does not mean that they are all in decline. There is no assurance of a profit—that is why QOFs are most likely to invest in Opportunity Zones that are in hot markets and already experiencing economic growth—and likely gentrification. States and local jurisdictions that sweeten the pot may convince investors to incur more risk.


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