Concerns that the election of Joe Biden as president would be the death knell for Opportunity Zones (OZ) were assuaged when his Build Back Better (BBB) plan featured the OZ tax incentive as part of his approach to advance racial equity across the American economy. The plan noted, however, that the OZ incentive was not living up to its promise and proposed to reform it accordingly. Consistent with criticisms that OZ was not being implemented as policymakers intended, for example that the incentive was benefiting wealthy investors more than OZ communities, Biden’s BBB plan proposed three primary revisions to the OZ program to fulfill its promise to advance racial equity, small business creation, and home ownership in low-income urban, rural and tribal communities.• Incentivize OZ funds to partner with non-profit and community organizations to create jobs and provide direct financial benefit to residents of the zones.
• Make OZ investments transparent by requiring recipients of the OZ tax benefit to provide detailed reporting and public disclosure of their investments and the impact they have on poverty status, affordable housing, and jobs in the zones.
• Requiring the Department of Treasury (Treasury) to review OZ investments to ensure OZ benefits are allowed only when the investments result in clear economic, social and environmental benefits to a distressed community.
Some of these ideas could be accomplished through regulatory or other executive action, while others will require legislative change. They are generally consistent with the principles behind bipartisan proposals that were introduced in the last congress and will need to be reintroduced or that are under development for introduction in the new congress, including enhanced information reporting requirements that will provide greater transparency regarding the investments being made and the impacts they are having in the zones. Current Treasury and IRS reporting requirements are focused on the information necessary to administer and enforce the tax aspects of OZ rules and regulations; officials say requiring impact reporting is outside the purview of tax administration. Increased information reporting requirements will create additional work for those required to submit the data, but many view this as a reasonable trade-off to be able to demonstrate the effectiveness of the OZ incentive and in light of the considerable tax benefits.
Other proposals not mentioned in the BBB plan but under consideration on the Hill include:
• rescinding certain designated zones that may have met the technical criteria but not the spirit of the legislation and replacing them with zones that do,
• extending the time frames to qualify for deferral of tax on capital gains originally invested and the full 15% step-up in basis, and
• providing a mechanism to facilitate the launch of OZ projects and businesses.
Uncertainties arising from COVID-19, including demand for commercial space and business services, the value of property, the ability to obtain financing, and the extent of the overall economic impact of COVID, as well as government-mandated shutdowns and social distancing protocols, resulted in the pause or discontinuance of many OZ investments, developments and businesses as stakeholders rode out the pandemic. Many potential OZ entrepreneurs and developers have great ideas but lack the know-how to launch a business. These proposals would mitigate some of these challenges and encourage the use of OZ.
Although the original legislation that was the precursor to OZ was bipartisan in nature, many Democrats in congress have been particularly critical of the incentive since its enactment in the Republican-led Tax Cuts and Jobs Act (TCJA). However, Democratic mayors and others in the party are strong proponents, a force that Washington, DC lawmakers cannot ignore. Now that the party controls both the House and the Senate, they will have more control over what legislative changes are made to OZ. However, they will still need to coordinate with Republicans since issues like enhanced information reporting will require 60 votes in the Senate. Because it is not considered to have a budgetary impact, the budget reconciliation process that requires only 51 votes in the Senate (and is expected to be used by Democrats during this session of congress to make other changes to the tax code) cannot be used for information reporting. This was the mechanism used for the TCJA and provisions to measure impact were struck from the bill for that reason.
ADMINISTRATIVE ACTION, NOT LEGISLATION
Importantly, not every proposed change to the OZ incentive would require legislation. As a practical matter, investors, developers and entrepreneurs already have discovered in the three years since OZ became law that the most effective way to proceed with an OZ project or business is to engage with state and local government, business and faith community leaders and visionaries, business and social organizations, tax exempt organizations, and local residents so that the needs and preferences of the OZ community are being addressed.
Another Biden BBB proposal that could be implemented through administrative action is the recommendation to require Treasury’s blessing of OZ investments to ensure that the policy goals are being met. Whether this means a Treasury review to certify a Qualified Opportunity Fund (QOF), approving the investments the QOF plans to make, or reviewing investor tax returns before allowing tax benefits, this requirement is likely to result in delays, bottlenecks, and inconsistent treatment among QOFs and investors, discouraging the use of OZ and preventing the considerable benefits that could accrue to communities. Instead, enhanced information reporting included with the tax return filed under penalty of perjury could be relied upon and be subject to regular IRS audit procedures to verify compliance with OZ requirements. Such enhanced reporting could include the data necessary to determine the number of jobs created, how many affordable housing units were developed, the types of businesses formed, and other social and economic data necessary to evaluate the merits of OZ.
IMPLEMENTATION OF OPPORTUNITY ZONES
Although the OZ statute has been in place for over three years and two comprehensive sets of regulations have been finalized, questions about OZ implementation remain. Additional regulations and other guidance to clarify lingering issues, or to facilitate foreign investment by adapting withholding requirements on capital gains, could further intensify interest in the OZ incentive.
It is unclear whether the Biden administration will devote the same level of commitment and energy to the OZ incentive as did the Trump administration. Devoting resources at the White House and throughout the executive branch departments and agencies to prioritize, encourage and facilitate the use of OZ will be necessary to maximize the potential of the incentive. This includes outreach and partnering with OZ stakeholders, OZ champions, and other interested parties, like Historically Black Colleges and Universities (HBCUs) and the financial community. A high level of commitment would also support the use of OZs to achieve other policy objectives of the Biden administration such as sustainability, green energy, climate change, infrastructure, and racial and economic justice, including wealth building of OZ residents.
Legislative and administrative actions taken by the Biden administration and the Democratic-controlled congress will have a significant effect on the success and future of the OZ incentive and the communities that stand to benefit from it.
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