A group of bipartisan senators and representatives on April 7, 2022, introduced The Opportunity Zones Transparency, Extension, and Improvement Act (the Act). If enacted later this year, this legislation would be the first substantial update to the Opportunity Zone statute since it was enacted in 2017. The bill extends the deferral period for qualified capital gains through 2028, requires the sunset of certain Opportunity Zone tract designations, imposes new reporting requirements to promote transparency, and creates a new entity, the "State and Community Dynamism Fund" to provide assistance to state and local governments.
Background
The Tax Cuts and Jobs Act, signed into law on Dec. 22, 2017, created new tax incentives for making investments in low-income communities. These incentives, collectively referred to as the Opportunity Zone program, allow investors selling appreciated securities or other investment property to defer tax on those gains to the extent that the proceeds are reinvested in a Qualified Opportunity Fund. Further tax incentives allow for exclusion of both some of the deferred gain and any post acquisition gain if the investment in the Qualified Opportunity Fund is held long enough.
However, the full benefits of the program, as well as some of the original guardrails that were intended to promote transparency and prevent abuse, have not been realized because of a number of factors, including delays in the U.S. Department of the Treasury guidance, certain statutory deadlines and changes to the program during the budget reconciliation process. The new legislation seeks to update the Opportunity Zone program to correct those changes and return some of the original intended incentives for investments.
Opportunity Zones Transparency, Extension, and Improvement Act
If enacted, the legislation would make the following changes to the program:
Extension of Deferral Period: In one of the titles that has garnered significant interest, the bill would extend the deferral period two years, to Dec. 31, 2028, and also lower the requirements for the additional 5 percent step-up basis by one year, from seven to six years. This is in part an effort to account for the Treasury Department's two-year delay in issuing relevant final regulations, effectively delaying or discouraging certain investors from making Opportunity Zone investments and limiting the benefits that those investors could receive under the program. Under the bill, investors could continue to defer gains from investments in Qualified Opportunity Funds and provide the ability to meet the 10-year holding period, as Congress originally intended.
Sunset Opportunity Zones in Middle-Income Communities: The Act would end the Opportunity Zone designation for tracts with median family income (MFI) at or above 130 percent of the national MFI, unless the tract has a poverty rate of 30 percent or greater for non-student populations. States would have the opportunity to appeal any determinations under this provision, sunset additional zones and replace sunset zones with other eligible lower-income tracts. For existing investments, the Act creates grandfathering rules, along with requirements and conditions. The requirements for disqualifying and replacing zones would be based on 2020 census data, unlike the original program which used 2010 data.
Reinstatement and Expansion of Reporting Requirements and Oversight: The Act would also reinstate reporting requirements from the original Opportunity Zone legislation that were pulled out during the Senate budget reconciliation process and expand transparency and oversight in the program. These requirements would include reporting of additional information on investors in Qualified Opportunity Funds and the businesses in which they invest, and the Treasury Department would be required to publish an annual report on Opportunity Zone activity. The proposal would also set new penalties for failure to report under the reporting requirements, including $500 per day with a $10,000 cap for a fund's failure to comply ($50,000 for larger funds), and $2,500 per day with a cap of up to $50,000 or $250,000 for larger funds for intentional failure to comply.
Allowing Qualified Opportunity Funds to Invest in Other Funds: Under current law, Qualified Opportunity Funds cannot invest in other Qualified Opportunity Funds, which limits the ability of larger investors to invest in smaller projects. Under the proposal, partnerships could elect to be organized as a "qualified feeder fund" and invest in smaller Qualified Opportunity Funds.
Creating a State and Community Dynamism Fund: The Act would create a $1 billion State and Community Dynamism Fund, providing states, territories and the District of Columbia with assistance in an effort to promote projects and businesses in lower income communities. This would include technical assistance, capacity building and financing support.
Outlook
As with any tax legislation in the 117th Congress, the future of the Act is uncertain. But unlike the vast majority of legislative proposals that have continued to languish, the Act is a bipartisan, bicameral effort that has garnered little opposition. Notably, Sens. Cory Booker (D-N.J.), Tim Scott (R-S.C.), Mark Warner (D-Va.), Todd Young (R-Ind.) and Chris Van Hollen (D-Md.) introduced the legislation in S. 4065, and Reps. Ron Kind (D-Wis.), Mike Kelly (R-Pa.), Dan Kildee (D-Mich.), Terri Sewell (D-Ala.) and Jackie Walorski (R-Ind.) introduced it as H.R. 7467.
This broad-based support suggests that the proposal may be a likely option for inclusion in tax legislative vehicles moving forward, including during any lame-duck session of Congress later this year. As Congress moves forward in considering future tax packages generally or the Act specifically, it will be important to evaluate the specific proposals in the Act and how they might affect relevant Opportunity Zone investments and activities. If you have questions or need further information, please contact the authors.