Reviews of the new tax reform bill have been mixed. Historic tax credits were retained, but the terms of claiming the credit changed. Other tax incentive programs were modified or done away with entirely. Depending on whom you ask, these changes can be positive or negative.
One change of the tax reform of 2017 that has gotten a lot of attention is the addition of Opportunity Zones. This program was championed by Senators Tim Scott (R-SC) and Cory Booker (D-NJ) and advertises to inject economic incentives to combat geographical inequality. US Census Bureau statistics point to stagnation in primarily rural counties where jobs and businesses have dropped over the last decade. In the 1990s, more than 50 percent of all counties grew at the national rate. Now only 25 percent do.
What is an Opportunity Zone?
The Opportunity Zones program is set up to benefit investors who invest in new businesses and development in census tracts approved as an Opportunity Zone (OZ). The program is market-based and requires no public money. Up to 25 percent of a state’s low-income census tracts - determined by population, income, and local input - are designated by governors and approved by the U.S. Treasury and the IRS.
Any corporation or partnership may self-certify an opportunity fund as an investment vehicle for capital gains tax deferment on the sale of another investment. While IRS rules are still being written, there is not expected to be a minimum or a maximum on the funds. Time is the primary constraint as it is expected that the fund will have to invest 90 percent of its assets in OZ projects within six months. And currently these investments must be made by the end of 2019 to get the full benefit of a 15 percent reduction in deferred taxes for investments owned seven years as the program is due to sunset December 31, 2026. (Investments owned for five years are reduced by 10 percent.)
What does this mean for historic rehabilitation projects?
OZ funding will not be enough on its own to fund a project. Combined with incentives like historic tax credits, however, OZ funding can help fill the capital stack for projects in economically depressed areas. Because of this, we expect that there could be interest in historic rehabilitation in areas that previously may not have been fully feasible before.
It may not be possible to draw a straight line between OZ funding and HTCs, but there might be parallels. Many people in the industry have likened the program to New Markets Tax Credits (NMTC), a program that is occasionally twinned with HTCs to fund rehabilitation projects. They have been sibling programs, but do not directly correlate in terms of usage.
The new OZ approach may create opportunities for investments in historic assets that that NMTCs do not necessarily create. Theoretically, an individual, or small group of individuals, could form a corporation or partnership to make smaller investments in OZs. Because of the complexity of the NMTC structure, it isn’t often economically feasible for a small NMTC project, while smaller projects may dovetail nicely with a combination of HTCs and OZ investments.
In addition to new businesses, many states are focused on making funding available for workforce and affordable housing opportunities that can utilize the OZ program. Technical guidance from the IRS suggests that LIHTC, HTC, and NMTC projects will be qualified investments; however, there are expected to be exclusions for projects that include “sin businesses” like golf courses, country clubs, massage parlors, gambling venues, or stores where the principal business is sale of alcoholic beverages for consumption off premises.
We know that historic preservation is a function of community revitalization. If the program incentivizes investment in these communities as it is designed to do, it will make these projects all the more probable as new businesses are encouraged to move in. But the bottom line is that the potential impact of OZs is yet unknown. We must wait and see how guidance is structured and how investors will respond.