When Congress enacted sweeping changes to the tax code in 2017, Allen Alley paid close attention. The technology investor and former Republican candidate for governor of Oregon was specifically interested in a little-known provision that created “Opportunity Zones” — neighborhoods designated as economically distressed by the governor of each state.
Under the new GOP Tax Cuts and Jobs Act, investors like Alley could create Opportunity Funds to invest in businesses and real estate in the designated neighborhoods with payouts from other investments, deferring the capital gains tax they would have had to pay. What’s more, Alley can avoid paying capital gains tax on the appreciated value of his Opportunity Zone investment altogether if he holds onto it for 10 years.
The impetus for these juicy new tax incentives? Congress wants to give wealthy investors an incentive to cash out their holdings and funnel that money into underresourced communities.
Sensing a rare opportunity, Alley sprung into action. The investor — who in 2009 walked across Oregon in 37 days as part of his unsuccessful gubernatorial bid— co-founded the Obsidian Opportunity Fund to create solar energy projects in newly-established Opportunity Zones.
“There’s been wealth created in the technology industry that hasn’t necessarily been shared equally across the United States in every region and in every corner,” said Alley, who invested his own money from tech deals, like the sale of Zapproved, to bankroll his venture. “This is an opportunity to take some of that money and reallocate it into areas that may not have received these investments before.”
But not everyone is as bullish as Alley about Opportunity Zones, which allow investors to avoid large tax bills and encourage development in some already rapidly changing neighborhoods.
“It could be a total gentrification machine,” said Maiko Winkler-Chin, Executive Director of Seattle Chinatown International District Preservation and Development Authority, a quasi-governmental community organization.
In April, Washington state Gov. Jay Inslee selected 139 census tracts to become Opportunity Zones, including Seattle’s International District and parts of the Central District. At the time, he said they “have the potential to provide a much-needed boost to communities and target development projects, strengthening the local economies and creating jobs.”
But Winkler-Chin is concerned about the lack of restrictions or parameters around the types of projects Opportunity Funds can invest in.
“There’s nothing needed to show that you are providing a public benefit and thus should receive a capital gains reduction in perpetuity,” she said.
Alley recognizes those concerns but believes that Opportunity Funds ultimately unlock frozen capital.
“I have friends that invested in some of the biggest names in the Valley and the stock just sits there as ones and zeros on a computer screen,” he said. “This is an opportunity to turn those ones and zeros into cash that you can invest in these communities and not only make a great return, but actually do something better.”
For Alley, Obsidian’s investments focus on rural communities in Oregon, but urban neighborhoods, like Portland’s Pearl District, are also included.
Here’s how an Opportunity Zone investment might play out:
— An investor makes $500,000 selling Amazon stock. She has 180 days to invest those funds in a designated Opportunity Zone Business, so she creates one to buy an apartment building in Seattle’s Central District. This means she can defer paying capital gains tax on that $500,000 until 2026.
— If she holds onto the building for 10 years, she won’t be taxed on any appreciation of its value. After 10 years, she sells the building for $900,000. She pays zero capital gains tax on the $400,000 she made on the sale.
There’s no cap to the amount of money investors can put into Opportunity Funds but there are some caveats. To receive the maximum tax benefits, investors must act by October 2019. At least half of the Opportunity Fund business’s gross income must be generated in the Opportunity Zone to qualify. That makes sense for real estate but means we’re not likely to see funds investing in technology businesses that want to sell products worldwide.
The tax benefits are attracting a lot of attention from business leaders and real estate developers, according to George Munro, a tax attorney with Amicus Law Group in Seattle who is helping clients better understand Opportunity Funds
“It’s a tremendously powerful tax tool,” said Munro. “I could see many, many wealthy individuals who take advantage of these rules.”
Silicon Valley had a hand in creating the new provision. Napster founder and tech celeb Sean Parker helped craft the Opportunity Zone section of the new tax code, according to Recode.
More than 70 Opportunity Funds have already been formed, according to data compiled by accounting firm Novogradac. In the Bay Area, March Capital Partners established a $23 million Opportunity Fund, according to an SEC filing. Real estate veteran Greg Genovese set up an Opportunity Fund in Seattle. And savvy tech companies are looking to grow in urban Opportunity Zones.
The Long Island City neighborhood of Queens, where Amazon just announced plans to build another headquarters, is an Opportunity Zone. As if that news weren’t enough to spark a real estate land grab, many developments in the already gentrifying neighborhood with views of the Manhattan skyline will not be subject to the capital gains tax that investors would’ve otherwise paid.
It isn’t clear whether that influenced Amazon’s decision, but the Seattle-based tech giant could benefit from the provision. If Amazon sets up a real estate business as an Opportunity Fund, it could reap the tax benefits.
Amazon did not respond to questions about whether Long Island City’s designation as an Opportunity Zone played a role in the company’s HQ2 decision.
Most of the communities designated as Opportunity Zones are not at risk of gentrifying but Long Island City, like some neighborhoods in Seattle, Portland, and the Bay Area, concern critics of the new tax code. They’re concerned about added strain on real estate markets in neighborhoods that are already growing rapidly. In cases like Long Island City, development was almost certain without the Opportunity Zone designation but with it, fewer tax dollars will be collected.
Brookings Institution researchers Hilary Gelfond and Adam Looney studied the Census tracts selected as Opportunity Zones and found that in some cases, like Long Island City, “states sought loopholes or picked places that did not need the help.”
“Some are areas clearly in distress,” they wrote. “Others, not so much. That’s a problem for the program’s impact; poor geographic targeting reduces the impact of the program and limits the benefits that accrue to poor residents.”
Winkler-Chin worries about communities like Long Island City and her neighborhood, the International District in Seattle. She said encouraging rapid development can be “overwhelming for a community.”
Alley says he and his colleagues are aware of the concern and “definitely sensitive to that” but confident that “net-net it’s a very good thing.”
“If you think about it broadly, at the highest level, you’re increasing money supply,” he said. “This is a dollar that was invested 15 years ago that’s now worth 100 more dollars.”