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by Casey Woods, Executive Director | April 18, 2019
Helping people invest in their community is one of the most important jobs in economic development. We know that if people inside a community won’t invest, people outside of a community certainly won’t. We also understand that catalyst tools are necessary to help decrease risk and improve property values. Over the past decade, Emporia Main Street has assisted with over $60,000,000 worth of reinvestment in the downtown area, and there is a new tool available that may help people looking to invest in our community. This article will focus on Opportunity Zones at a high level. There are still some aspects of this program that are “up in the air”, but we want to provide information for individuals that may want to utilize this tool to invest in Emporia. We will embed several educational links throughout this article so people can do some additional research on their own.
Opportunity Zones allow people to defer or offset capital gains taxes realized by participating in business and/or building operations within designated zones for a set number of years. Capital gains taxes are typically realized after the sale of assets, like stocks. Let’s use an example to illustrate an Opportunity Zone transaction:
Bill sells his stock in XYZ Company, and realizes a $100,000 gain on the stock sale. Typically, this $100,000 would be subject to capital gains tax. However, let’s say that Bill buys interest in a qualified opportunity fund on April 2, 2019 for $100,000. Bill wouldn’t show a recognized “gain” on the stock sale in 2019. If Bill owns interest in the qualified opportunity fund on December 31, 2019, he would pay tax on 85% of the “original” gain (he would pay tax on $85,000 gain in 2026 because $100,000 multiplied by 85% is $85,000). Let’s say that Bill holds the property for ten years, and that the property Bill purchased through his interest in a qualified opportunity fund appreciates to $200,000 during that time frame. Bill could sell the property that he held for 10 years, and pay no tax on the economic gain for the property, if he meets the ten year holding period. If Bill invests an additional $50,000 in the property (not from capital gains) to “fix up” the structure, the additional $50,000 won’t qualify for the ten year exclusion, and one-third of the $50,000 injection will be taxable upon the sale of the property.
Where is the Emporia opportunity zone? Please see the map below. The opportunity zone in Emporia is basically south of 6th Avenue and east of Rural Street through most parts of the city limits. CLICK HERE to check out Kansas opportunity zones.
Confused yet? Let’s get into a few nuts and bolts, and then attempt to provide some clarity. Deferring capital gains essentially means that you are simply putting off your capital gains tax bill. So, if you simply purchase and hold property, you will still eventually pay the tax associated with capital gains, but deferring the bill means that you can make other investments in the interim. If you hold an opportunity zone property for five years, you can get a 10% discount on your capital gains liability invested. If you hold an opportunity zone property for seven years, you can receive a 15% discount on your capital gains liability invested. Any capital gains on investments made through the Opportunity Fund accrue tax-free as long as the investor holds them for at least ten years.
There are some technical hurdles that are still being worked out on the federal level. Opportunity zones often cross over with areas designated as historic districts, or with areas suitable for usage of New Market Tax Credits. In theory, the historic tax credits and NMTC’s should make opportunity zones highly attractive to investors where crossovers occur. In practice, there are some basis requirements in opportunity zones that need clarification in opportunity zones, and many New Market Tax Credit usage plans are based on acquired debt, whereas opportunity zones require an equity injection from the capital gained through the sale of stock or other qualifying appreciable assets.
Investments in opportunity zones must be made through a qualified opportunity fund (CLICK HERE for description). Funds must annually self certify with the IRS utilizing form 8996 (CLICK HERE). Some real properties that include “sin” uses (liquor stores, gambling, golf courses, and a few others) are excluded from use. Newer regulations indicate that 1231 gains (CLICK HERE) appear to qualify, and gains on the sale of a personal residence should also qualify. Substantial improvements are required for most held properties, and the test for “substantial” is a minimum of one dollar over the building’s value (for example, if you purchased a building for $100,000, you would need to invest a minimum of $100,001 to meet the “substantial” requirement). A ten year proforma for the project is required.
For those that would like a more detailed prospectus on the utilization of opportunity zones, please check out this information from Accelerator for America (CLICK HERE).
Cities and states throughout the nation are utilizing opportunity zones to attract outside investment in the redevelopment of communities. A simple identification page on city web sites (and linked through area economic and community development groups) can be used to entice investors in targeted development. Again, these investors want to inject cash in developments in the planning process before the execution stage- most are not developers themselves. Cities cited for doing a great job in communicating opportunity zone options include Stockton, California (CLICK HERE), and Erie, Pennsylvania (CLICK HERE). Communities that market investment options should be prepared to create a “one stop shop” to facilitate investments.
For some rural states that lack the resources to generate a “one stop shop”, a statewide marketing approach is utilized. Alabama has a state opportunity zone site, which includes access to a variety of experts needed to facilitate opportunity zone transactions (CLICK HERE). Quality opportunity zone investments require an attorney, accountant, title/abstract/escrow company, developers willing to take on external capital, and a municipality willing to work through issues with complex developments in a defined time frame.
At Emporia Main Street, we think that it is important for the public to have a basic understanding of incentives available to improve the community. We are not experts in opportunity zone funding, but we are working hard to research options and provide conduits to groups that can guide opportunity zone based investment. There are opportunities within our community, and outside capital, when combined with local work ethic and ingenuity, could provide people with the resources necessary to continue the ascension of Emporia. If you are interested in utilizing opportunity zones, or other funding options, please contact Emporia Main Street and we will do our best to help!