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 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 capital gain 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 27th, there are no regulations in place clarifying how social impact will be measured, monitored, or regulated. As a result, community investments may lead to gentrification, displacement, and inequitable development. There is also concern regarding the lack of input from communities and residents in the future of their own neighborhoods. These issues may be exacerbated by the speed at which the program is developing.
Beyond concerns regarding negative
impact, certain Opportunity Zones may not have needed tax incentive to spur investment. 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. Finally, as O Funds are developed, some are concerned that there is insufficient connectivity between potential O Funds and high-impact projects.
Mission Investors Exchange is currently compiling additional concerns and challenges, as well as actions that organizations and local leaders are taking to address these issues. If you have any thoughts or ideas, please email Anjali Deshmukh
This program is developing quickly, and foundation impact investors may play a unique role in keeping impact at the heart of the program — as local community convenors, supporters of research and monitoring, investors, and more. As the program continues to evolve, visit Enterprise Community Partners, Summit Consulting, the Economic Innovation Group (EIG), the CDFI Fund, and the U.S. Treasury for additional details and regular updates. Visit MIE's OZ Library for evolving resources.