Last year's tax overhaul created a massive new incentive for investing in some of the United States' poorest neighborhoods. The brand new "opportunity zones" enable private investors to re-invest their profits into businesses that are located in parts of the country that are generally starved from outside investment.
John Lettieri, co-founder and president of the Economic Innovation Group in Washington, DC, helped to design this new tax incentive and explained how it will likely work.
Q: What is an opportunity zone?
A: It's a low-income community that gets selected by a state's governor for this new federal tax incentive. Governors can choose up to a quarter of their states' low-income census tracts for opportunity zones.
We're still waiting for the last four states to have their tracts approved by the U.S. Treasury Department. But when all is said and done, roughly 8,700 Census tracts — about 11 percent of all Census tracts — will be designated as opportunity zones. These are urban centers, rural areas and suburban communities.
Q: How does this tax break work?
A: Unlike other programs, investors aren't getting any upfront tax credits. They can reinvest their capital gains from other investments into these opportunity zones. Over time, they get preferable treatment on the profits from these new investments. After 10 years, additional capital gains are tax free.
Let me give you a hypothetical. If I rolled $100 into an approved fund for one of these zones and the investment goes to $200, that profit is tax-free provided that I hold onto the investment for 10 years.
Q: Most of the zones have been approved by Treasury. What are the next steps?
A: Now that the map is almost set, Treasury and IRS have to release guidance to create opportunity funds for raising and deploying the capital into these communities.
States are figuring out their recruitment strategies to bring in investors, while investors are looking at how they can raise funds. But before any capital gets deployed, investors want to see the guidance for establishing these funds. We should expect some clarity on this guidance in the third quarter of this year.
There is nothing guaranteed about opportunity zone. Just because you have a designated census tract, it doesn't mean the capital is going to automatically flow there.
Q: How are funds set up?
A: This is going to be mostly private sector led in terms of the creation of funds. There is no cap on the amount of dollars that can go through opportunity zones.
Q: Are any types of investments forbidden?
A: There are several carveouts. One is the "sin list," such as casinos, golf courses and massage parlors. Another carveout is for financial companies that invest and lend as their core business.
Q: What does this mean for small businesses?
A: One of the most important trends we see nationwide is concentration of capital in a few areas. About 80 percent of venture capital goes to California, Massachusetts and New York.
Through opportunity funds, this will have the opposite incentive to encourage people to start and scale their businesses locally. This gives investors a reason to make equity investments in these impoverished communities.
There was $6.1 trillion in unrealized capital gains as of the end of 2017. That is a massive pool of capital. Even if a fraction of it gets invested in low income communities, it's a sea change.