A key piece of legislation meant to drive continued investment in Opportunity Zones may stall in Congress until next year.
When the Opportunity Zone program came to life as part of the Tax Cuts and Jobs Act (TCJA) of 2017, tax benefits for individual investors were one of its main selling points. Meant to spur investment in economically depressed areas, the legislation granted Qualified Opportunity Fund investors a tax deferral on their capital gains until 2026. Those who held their investment for five years would also get a reduction of 10% in their taxable gains, while those who committed to a 10-year hold would not be subject to taxation on their eligible gains until 2047.
The Opportunity Zones Transparency, Extension and Improvement Act (H.R. 5761), introduced in the House of Representatives last fall, would defer capital gains on qualified Opportunity Zone investments until 2028, two years longer than the program’s current cutoff. It would also reinstate reporting requirements for Opportunity Zones, clean up zone designation to exclude not economically disadvantaged areas and create a special fund to drive public and private investment in the program. By all accounts, the bill, co-sponsored by both Republican and Democratic representatives, has bipartisan support and stands a good chance of eventually passing. However, dysfunction in Congress means it will likely not get approved until after the November election.
“This year, there is little chance that there’s going to be tax legislation, and that’s because we are right before the election,” said Anya Coverman, president and CEO of the Institute for Portfolio Alternatives, an advocacy group for the portfolio diversifying investments industry.
While a bill passed in the House at the beginning of the year—The Tax Relief for American Families and Workers Act—it did not include Opportunity Zone provisions. It also stalled in the Senate because some Republican senators, including Senate Finance Committee member Mike Crapo (R-ID), would prefer to postpone making tax policy changes until 2025, when many of the TCJA’s provisions expire, Coverman noted.
“And also, it being an election year, Republicans don’t want to have a big tax win on the Democratic side,” she added.
H.R. 5761 has support from both parties, “but there simply aren’t many windows for passing tax legislation in the current closely divided Congress,” agreed John Lettieri, CEO of Economic Innovation Group (EIG), a bipartisan public policy organization focused on the U.S. economy. Lettieri pointed to similar gridlock emerging over child tax credit legislation.
“At worst, I anticipate that Opportunity Zones will be a significant part of the discussion next year as tax policy returns to the forefront thanks to the expiration of major provisions of the Tax Cuts and Jobs Act,” he wrote in an email.
Will investors care?
Deferrals on capital gains taxes are crucial for investors considering putting their money in Opportunity Zone funds and for the program to achieve its aim of helping underserved communities, say industry insiders. Given how long it took after the passage of the TCJA to clarify Opportunity Zone provisions and educate investors on its benefits, the program still hasn’t realized its full potential, according to Kelly Ann Winger, CEO of Alternative Wealth Partners LLC, an emerging private equity manager. Funds run by Alternative Wealth Partners have investments in projects located in Opportunity Zones, including manufacturing, energy and infrastructure businesses.
So far, individual investors have primarily used the Opportunity Zone program to mitigate taxes on their capital gains when they couldn’t do 1031 exchanges, which are more limited, Winger noted. But today, more private equity and venture capital players are considering the program because it would allow them to pursue long-term returns through a tax-free vehicle.
“I think it’s important that [the program] keeps going because there was a lot of wasted time in the first five years of the program,” said Winger. “We’ll start seeing the results of the people who initially invested using this strategy back in 2017 in the next couple of years, as those capital gain tax-free exits start in 2027. I think that not enough people knew all the right information; there is still not a lot of clarity around how the program works or the incentives that can be stacked on top of each other.”
Winger added that investors could reap outsized returns if they put their money into Opportunity Zones over the next five years, provided Congress extends the program.
A 2023 working paper by the U.S. Office of Tax Analysis found that for the tax year 2020, individual investors accounted for approximately 85% or 24,000 electronically filed reports for qualified investment in Qualified Opportunity Zones. The office also determined that the median individual investor in a Qualified Opportunity Fund had an adjusted gross income of roughly $730,000. The average amount invested in these funds was around $1 million, with the median deferred gain of approximately $250,000.
Professional services firm Novogradac & Company LLC reported that from the inception of the Opportunity Zone program through year-end 2023, Qualified Opportunity Funds raised at least $37.62 billion. In 2023, Qualified Opportunity Funds, tracked by Novogradac, reported that their fundraising raised $3.54 billion in equity for 1,461 funds. Most of the funds tracked by the firm (66%) raised less than $10 million, which indicates that they focused on one specific project rather than multiple deals, Novogradac researchers noted.
One real estate investment firm that focuses on raising money for such single-asset Opportunity Zone funds is Richmond, Va.-based Capital Square. The RIAs the firm works with appreciate the ability to perform due diligence on specific deals in the single-asset funds and see what they are allocating money to, according to Adam Stifel, chief development officer. The company has raised approximately $250 million from retail investors for eight single-asset funds. Most of the assets involve multifamily development.
It took a while for investors to get educated on how Opportunity Zones work, Stifel said. However, “It’s now almost become a household word in the tax world, like 1031 is, and the program needs the time to take advantage of that. I think most people understand the basics of what an Opportunity Zone is at this point, and the interest level is really high on the retail side.”
He noted that Opportunity Zone investments’ tax advantages are a significant selling point. So far, Capital Square has completed the projects in its Opportunity Zone funds, stabilized them, and refinanced them before the program’s 2026 sunset on capital gains deferral. If the program expires less than two years from now, Capital Square could still raise equity from institutional investors and other types of L.P.s. Still, the interest from individual investors would likely dampen, according to Stifel.
“It’s hard to overstate how important that 10-year benefit is,” he said. “There could be slowing and less interest from our investor base if we are no longer able to achieve a refinance distribution before our investors’ original capital gain tax is due.”
Both Stifel and Winger believe the extension bill will eventually be adapted. Since Congress enacted the program during the Trump administration if he wins a second term, there would be little reason for him to undo his legacy by dismantling the program, Winger noted. Likewise, if Biden wins in November, the Democratic party will want to keep investment flowing to underserved areas, she said.
Coverman is more cautious about how things might play out. She noted that Congress will likely be more concerned about expenditures next year than in 2017. That means supporters of the Opportunity Zone program must show that its benefits would outweigh the negative budget score the extension of its tax breaks would receive.
“It’s going to be important to keep this policy supported on a bipartisan basis, but that will be done by showing policymakers the [program’s] positive impacts,” she said. “We are early on in what I think is going to be a very big and nuanced conversation next year.”