Tax policy has long been a tool for encouraging (and discouraging) investment in places, innovations, business expansion, and community development. From New Markets Tax Credits (NMTC) to more recent programs like Pay for Success (PFS), many of these financing incentives also receive bipartisan support from Congress.
Contained within the Tax Cuts and Jobs Act of 2017 was a new incentive to attract investments in communities: the Investment in Opportunity Act. Often called the Opportunity Zone (OZ) program, this tax benefit provides federal tax incentives for investors who invest capital gains into designated investment funds, called Opportunity Funds (O Funds), in low-income communities throughout the United States.
Putting Capital Gains to Work
The OZ program is intended to spur long-term investments in low-income census tracts in the U.S. The new law allows investors to place unrealized capital gains (a profit from an investment that hasn’t yet been sold) into authorized O Funds that invest capital into OZs. The greatest benefits would go to investors who invest for 10 or more years. Below are basic elements of the program’s tax benefit:
- Investors can temporarily delay including realized capital gains (profit from investment that has been sold) as taxable income when they’re reinvested into an O Fund.
- The longer the original capital gains remain in an O Fund, the less of the original amount is included as taxable income when it is taken out of an O Fund: after 5 years, 10% of capital gains can be excluded from taxes, while after 7 years, 15% of that original gain will be excluded.
- All capital gains resulting from an O Fund are excluded from taxable income if it remains within that fund for at least 10 years.
In this way, O Funds may activate passive, patient capital by connecting investors to projects in low income communities. The pooled fund model may also increase the scale of investments while lessening the risk to any individual investor.
Concerns and Challenges
While the OZ program comes with significant potential for positive impact, there are also serious risks. For example, as of August 2019, many impact investors believe there are insufficient regulations in place clarifying how social impact will be measured and monitored — or how investors will be held accountable. Without such regulations, policy makers will have very limited information about the effects of the program, and few incentives are in place to deter negative community outcomes, including gentrification, displacement, and inequitable development. There is also deep concern regarding the lack of input from communities and residents in the future of their own neighborhoods. Finally, as O Funds are developed, some are concerned that high-impact investees and investors are not connecting, due to geography or a lack of overlap in networks.
Beyond concerns regarding negative
outcomes, certain Opportunity Zones may not have needed tax incentive to spur investment in the first place — and thus may be receiving tax incentives where they were not necessary or appropriate. See early research by the Urban Institute
exploring which Opportunity Zones may have already been exhibiting signs of socioeconomic change — indicators of pre-existing growth and/or gentrification. See this New York Times article
questioning certain uses of the program.
These issues may be exacerbated by the speed at which the program was rolled out. In the spring of 2019, invitations for public comments to revise the legislation sparked a variety of responses from the impact investing community, focused in large part on how to avoid potential misuses of the program. To address some of these concerns, Senators Tim Scott, Cory Booker, Todd Young, and Maggie Hassan proposed changes in May 2019 that would require investors to share certain types of impact data with the Department of Treasury. However, the proposal has not yet passed into law, and there is no stated timeline clarifying when changes may occur.
Focusing on Impact
Although it is still far too early to know whether the overall outcomes of the program will or won't match its original intentions, impact investors — and particularly foundations — are playing a critical role in ensuring that "impact" remains the focus. Learn more about impact measurement in OZs on this page
dedicated to this topic.
Visit this post for ideas on how you can get involved. Visit Enterprise Community Partners, Summit Consulting, the Economic Innovation Group (EIG), the CDFI Fund, and the U.S. Treasury for additional updates. If you have any thoughts or ideas, please email Anjali Deshmukh.