The New Opportunity Zones

The idea of an “opportunity zone” is to offer an incentive, whether through a grant or a a tax break, for people and firms to invest in a place with relatively low levels of income and jobs.

Proposals along these lines have floated around for awhile under various names like “empowerment zones,” “enterprise communities,” “renewal communities,” and others. But the currently existing program of opportunity zones is a tax break that was discussed and proposed during President Obama’s administration, but became law as part of the Tax Cuts and Jobs Act signed into law by President Trump. The most recent issue of Cityscape, published by the US Department of Housing and Urban Development, has a symposium including research titles “An Evaluation of the Impact and Potential of Opportunity Zones” (2022, volume 24, number 1). I’ll provide the full Table of Content below. Here is an overview of some main insights.

In his introduction to the symposium, Daniel Marcin gives this quick overview of how the law works:

Opportunity Zones allow investors with capital gains to reinvest that money into Qualified Opportunity Funds (QOF), which then invest in OZs. Doing so has three main benefits.

1. The capital gains tax due on the original investment sale is deferred until the sale of the QOF investment or the end of 2026, whichever comes first.

2. If the investor holds the QOF investment for 5 years, the cost basis of the investment is increased by 10 percent. If held for 7 years, or 2 additional years, the cost basis increases by an additional 5 percent.

3. If the QOF investment is held for 10 years, then no tax is due on any gains on the OZ investment (IRS, 2021a).

As Marcin is quick to point out, this structure means that all evaluations of the program are preliminary. It took some time for the IRS to write up detailed rules of how they would work, and there has not been time for these holding periods of 5, 7, and 10 years to be completed.

An obvious question is what qualifies as an “opportunity zone.” The short answer is that state governors could make a list, within their state, of “low-income” areas defined as “generally a census tract with (a) a 20-percent poverty rate or higher, (b) a median family income of 80 percent or less than the metropolitan median family income, or (c) if not located in a metropolitan area, a median family income less than 80 percent of the state median family income.” For the record, a “census tract” is an area that usually contains from 1,200 to 8,000 people. There was also some wiggle room about choosing census tracts right next to these low-income areas. “Executives could select 25 percent of all tracts that were eligible, with a minimum of 25 in a state. In total, 8,766 OZs were designated.”

As you can imagine, there was also added complexity in how to decide if a business was really “in” an opportunity zone. For example, what if an existing business opened a small office in an opportunity zone? Not eligible. What if the business was physically based in the opportunity zone, but left the opportunity zone to provide services (like a housecleaning or landscaping company? Not eligible. In oversimplified terms: “The IRS ruled that, to qualify as an Opportunity Zone business, that business must earn at least 50 percent of its gross income from activity inside an OZ. … Opportunity Zone business property must be used “substantially all” of the time in an OZ.”

In their essay, Blake Christian and Hank Berkowitz argue: “The federal OZ program is arguably one of the most flexible, impactful, and bipartisan tax programs for helping disadvantaged communities in half a century.” They cite estimates that $75 billion had been invested in the opportunity zone program by the end of 2020. They point out that the program doesn’t just cover real estate, but also applies energy projects (like companies installing solar panels or insulation), infrastructure, active businesses, and public-private partnerships. Notice also that to get the tax breaks, the investor needs to commit to the investment for some years–in other words, this isn’t a tax break for flipping properties or other quick in-and-out investments. A common pattern seems to be that if the opportunity zone program can be combined with other business incentives, thus providing additional capital to (for example) a pre-existing program aimed at building more low-income housing.

It is fiendishly difficult to evaluate a program like opportunity zones. It’s unlikely that when governors were choosing among the census tracts eligible for opportunity zones that they did so at random. They may well have picked areas that they thought were more “ripe” for development. The funds going into opportunity zones could have been invested elsewhere–perhaps even in a neighboring census tract. In a broad sense, the gains from a program like this come from the sensible idea that investments to create jobs and economic activity in a depressed area have a bigger social benefit than similar investments in another area, because there are bigger spin-off benefits of improving economic activity in a depressed area.

That said, various studies in this issue give some promising results, for a program that has only existed for three years. One study found that OZ areas had seen faster growth of jobs and enterprises by about 2%. Another study found “that OZ tracts saw lower home price appreciation than did non-selected tracts before 2017. After 2017, however, OZ tracts had a 6.8-percent greater home price appreciation through 2020 over the eligible-but-not-selected tracts.” Another study found that if gentrification is defined as a “greater-than-average change in the percentage of tract residents older than age 25 with a bachelor’s degree,” then in Washington, DC, ” most OZs do not have a gentrification score higher than the city average.” In short, the gains from opportunity zones seem real, if modest.