How often are 150 people turned away from an IRS hearing on Valentine's Day? Almost never. But in standing-room only fashion, the much anticipated public hearing on Opportunity Zones took place last week in Washington D.C., after being delayed 35 days because of the partial government shutdown.
1. The 50% test for investing in a business has emerged as, arguably, the most important factor in the legislation right now. Why? If the IRS determines that 50% of the sales or gross income of a business that is taking on capital gains must be derived from within the Opportunity Zone in which it is located in order to qualify for an Opportunity Fund, that severely limits which and how many projects make for good investments.
Imagine a T-shirt design and printing company that operates in the rustbelt town of Braddock, Pennsylvania, known as the birthplace of Andrew Carnegie's first steel plant. Today, most of Braddock is designated as a Qualified Opportunity Zone. In order for the T-shirt business to meet the 50% test standard that would designate it as a Qualified Opportunity Zone, half of its T-shirt sales would have to come from inside Braddock. Never mind the significant retail sales the T-shirt designer conducts online with buyers across state lines.
The 50% test plainly hamstrings businesses residing within OZ's which seek qualification as OZ businesses. Confining them to deriving 50% of sales from within the boundaries of their OZ creates little incentive for investors to want to put capital into them.
But there's encouraging news for investors. "IRS asked a lot of follow-up questions about this issue," says Stockton Williams, Executive Directors of the National Council of State Housing Agencies. While affordable housing is the focus of those agencies, Williams recognizes, as do other Opportunity Zone advocates, the symbiotic relationship between investors and communities when it comes to redevelopment.
"I think the IRS is thinking very hard about [the 50% test], and they need to look at what's in the statute and what precedents exist elsewhere in the tax law. You need to first follow the statutes, but you need to be cognizant of how other similar provisions to the tax code apply and how they've dealt with similar matters, because they are important relationships throughout the code.
2. IRS appears to be willing to treat businesses in a similar way to how it treats real estate, for working capital purposes. The substantial improvement provision of the OZ legislation states that “taxpayers must double their adjusted basis in the property after purchase and during any 30-month period that they hold their qualified opportunity zone property.”
Any investor knows that a real estate project doesn't come together in a day. As such, this 2 1/2-year safe harbor period was written into the OZ provision to allow private investors to fully invest in an improvement project.
But business investors want this same time allowance, too. Many of the questions at the public hearing circled around allowing businesses in Opportunity Zones to take advantage of the 30-month investment time frame, just as real estate investors can. Judging by the feedback at the public hearing, IRS seems positively inclined to allow investments in businesses this working capital safe harbor of 2 1/2-years. This is very constructive, as business investments in the OZ legislation have taken significantly longer to come together than some of the more pioneering real estate OZ fund projects because of the cloudiness around regulations.
3. One group is saying, “Hurry up,” another is saying, “Hold on a minute,” and both are saying, “Don’t mess up.” 145 public comments were submitted to the Treasury regarding OZ regulation leading up to the public hearing, and more than two dozen people presented live testimony before the IRS on February 14th.
Investors from across the country who are able to participate in the tax incentive program recognize that the economics of Opportunity Zones become a little less valuable every day, given the hard stop date of December 2026 for realizing the tax deferral, so they’re hesitant to invest capital in Qualified Opportunity Zones over concern that the rules remain unclear.
Community-based organizations, too, are vocally concerned about how the tax cuts will or won’t create affordable housing and jobs for their residents. After all, Opportunity Zones were created as a part of the Tax Cuts AND Jobs Act. Yet advocates, through their lobbying efforts, express concern that the investments aren’t coming to fruition soon enough.
"Affordable housing issues are really important if Opportunity Zones are going to achieve their promise," says Williams of NCSHA, "but the first order of business is getting final program rules from IRS that enable capital to start flowing. Until that's done, I don't think you'll see a heavy volume of deals closing."
The IRS, therefore, must balance a very slender line if they are going to make community investors happy and spur the job growth that Opportunity Zones were intended to create in a very short period. The grand message can be codified to one simple phrase: Please make it good for investors, please make it good for communities, and please hurry up.