OZ Roadmap – Navigating the New Lines of the 2020 Census Tracts

on March 23, 2021
The opportunity zone program has taken quite a few twists and turns in its 3-year existence. Initially, there were more questions than answers about how the program worked, and many have blamed the program’s slow start on this early lack of guidance. Eventually two sets of proposed regulations were released (in October 2018 and April 2019), with requirements that did not always dovetail with the realities of a real estate development project or the start-up phase for a new business. Final regulations were released in December 2019 which, in part, reversed the Treasury Department’s position from the proposed regulations on a few critical issues. Then correcting amendments to the final regulations came out in April 2020 with several significant clarifications, as well as some new guidance. At about the same time, COVID-19 brought the world to a halt, including in the Land of OZ.Finally we enter 2021, hopefully putting the pandemic behind us and ready to get back to work. Although lingering questions remain about the OZ program, we have a fairly robust set of rules and projects are underway. It should be a smooth ride from here, right?
Keep your seatbelt fastened, since we are headed for a few more bumps. The new question on the table is what effect, if any, the redrawn census tracts from the 2020 census will have on the OZ program. Certain statements from the Treasury Department indicated that the OZ boundaries would not change even if census tract boundaries themselves changed as a result of updated census data. However, the Treasury Department’s 2020-2021 Priority Guidance Plan includes the impact of census tract changes to OZs. [1] Inclusion of an issue on the Priority Guidance Plan indicates that the IRS and Treasury believe that additional guidance is needed on that issue. Unfortunately, this latest uncertainty is, again, hindering the effectiveness of the OZ program by planting doubt in the minds of investors, developers and other OZ stakeholders.

Let’s walk through the history of the OZ designations, the existing guidance we have on the OZ designations, the census tract changes from the 2020 census, and what the future of the OZ program looks like from here.

OPPORTUNITY ZONE DESIGNATIONS

The first few months of the OZ program were arguably one of those most critical phases of the program. After being born into existence by the TCJA in December 2017, the first step of the OZ Program required the governor of each state (or U.S. Territory) to submit its opportunity zone nominations to the Treasury Department within just a few months. [2]

 The OZs were defined to be certain designated census tracts. In order to be eligible for nomination by a state (or U.S. Territory), a census tract had to meet certain low-income criteria, [3] and a small number of each state’s nominations could include census tracts adjacent to qualifying low-income census tracts, as long as those adjacent tracts met specified criteria. [4] By June 2018, the IRS released Notice 2018-48 (OZ Notice) which listed all of the census tracts designated as OZs. [5]

Given that the census occurs every ten years, the fact that the OZ qualifications were based on 8-year old data at the time of designation was a point of discussion. A neighborhood might have looked very different at the time of the 2010 census than it did in 2018 when the governors were nominating certain census tracts to be OZs. Would there be a reassessment of a census tract’s low-income designation at some point? And what would happen if the boundaries of a census tract changed as a result of the 2020 census?

CAN OPPORTUNITY ZONES CHANGE?

The language in the Internal Revenue Code does not suggest that the OZs can change over time. Although technically the designation of a census tract as an OZ expires after 10 years, [6] the final Treasury Regulations make clear that the expiration of the zone designations does not impair an investor’s ability to elect the benefit of the “10-year rule.” [7]

 The preamble to the final Treasury Regulations also includes this statement: “Section 1400Z-1 provides the statutory authority for one round of nominations and designations. Thus, there are no current or proposed plans to reopen consideration of additional census tracts to be designated as [opportunity zones].” [8]

So, an existing census tract designated as an OZ should remain an OZ even once it “expires”, and no new census tracts should be added. But what if the boundaries of a census tract designated as an OZ change, and what if a census tract designated as an OZ disappears entirely?

When this question was first raised as early as 2018, many practitioners and other OZ stakeholders took comfort in a statement that was posted on the Opportunity Zone Resources page of the Community Development Financial Institutions Fund (CDFI Fund) website. That webpage included, and still includes as of the time of publication of this article, the following text: “Based on IRC 1400Z-1, designations are based upon the boundaries of the tract at the time of the designation in 2018, and do not change over the period of the designation, even if the boundaries of an individual census tract are redefined in future Census releases.” [9]

 It is worth a small deviation here to understand the relationship of the CDFI Fund, which is an agency of the Treasury Department, to OZs. The low-income criteria that was part of evaluating whether a census tract could be designated as an OZ was actually a cross-reference to the criteria used to determine eligibility of a particular census tract for the new markets tax credit program, [10] and the new markets tax credit program is administered by the CDFI Fund. The Opportunity Zone Resources page of the CDFI Fund website includes a statement that the CDFI Fund is supporting the IRS with the OZ nomination and designation process. 
Since the CDFI Fund is an agency of the Treasury Department, there is a relatively easy trail of breadcrumbs to connect the CDFI Fund to the qualification of certain census tracts as OZs, especially given the CDFI Fund’s role in administering the new markets tax credit program (which program also relies on the classification of census tracts in meeting low-income criteria). The problem is that “FAQ” pages, as well as other statements on the IRS and Treasury Department websites, cannot be relied upon by taxpayers in a dispute with the IRS. So, if the IRS ultimately decides that the OZ boundaries can change as a result of the 2020 census, resulting in a particular real estate development or business no longer being in an OZ, the statement on the CDFI Fund website is not binding on the IRS.

CHANGES FROM THE 2020 CENSUS

After each census, the Census Bureau reviews the new data through a process known as the Participant Statistical Areas Program (PSAP). The PSAP relies on local committees, comprised of regional planning groups and local governments, among others, to review the census tract boundaries and propose changes based on the latest data. [11] According to a recent article posted in Bloomberg, there was a fair amount of lobbying to get specified results through the PSAP program in connection with the 2020 census. [12] Because the OZs are determined by reference to specific census tract numbers, if a census tract designated as an OZ in the OZ Notice were to be expanded, then perhaps the new larger census tract should be considered an OZ.

 Expanded OZs are not the only issue to consider. A preliminary study undertaken by Novogradac estimates that while 20.9% of OZs increased in size, roughly the same amount (20.4%) decreased in size. [13] The Novogradac analysis also estimates that 15.3% of OZs were split into two or more tracts, [14] so some census tracts that were designated as OZs may no longer exist at all. If your project is now outside of an OZ, what does that mean? Are existing investors grandfathered into the tax benefits? What if additional investment is needed?

 Less than half (43.4%) of OZs had no change, which means that the majority of zones were altered in some way. [15]
 If you would like to check whether changes have been made to a particular census tract, you can take a look at Novogradac’s Opportunity Zone Mapping Tool. [16]

WHERE WE GO FROM HERE

The good news is that this issue is on the Priority Guidance Plan for this year, so it is on the IRS’s radar as an area where guidance is needed. Although not every issue on the Priority Guidance Plan gets addressed as quickly as we might hope, the effect of changing census tract boundaries is time sensitive given the various deadlines and timing requirements of the OZ incentive, so fingers crossed this is one that will be prioritized. Furthermore, many OZ stakeholders are bringing this issue directly to the IRS and the Treasury Department’s attention with comment letters and other communication. Lastly, the fact that this issue is getting attention in the press, such as the Bloomberg article mentioned above, may also help to get the attention of the right people in Washington, D.C. [17]

The bad news is that the alleged lobbying and other efforts in connection with the PSAP and the 2020 census is only going to give critics of the OZ program more ammunition. If new projects are eligible for QOF investments, and existing projects are kicked out of eligibility, that would result in serious harm to the OZ program.

Assuming that we do get clarity from the IRS and Treasury Department on the changes resulting from the 2020 census, here are a few possible outcomes.

• “Only more” – The boundaries of the original OZs would continue to be respected, and any new areas included in expanded census tracts designated as OZs would also be included. This would help to increase investment in OZs, but any expanded zones that were the result of lobbying efforts would be ripe for attack, especially if the expanded zone would no longer meet the low-income criteria.
• “Grandfathering” – Any projects already in process would be grandfathered in as qualifying projects, if those projects are in zones that decreased in size, or OZs that disappeared. The trick here will be determining what stage your project needs to be at in order to be swept in under a grandfathering rule. Will construction need to be underway, or can it qualify as long as the property has been acquired by a specified deadline? What about property under contract by the deadline even if you haven’t closed yet?
• “Low-income only” – Any OZ with new boundaries (or maybe all OZs?) would keep their designations as OZs only if they meet the specified low-income criteria as of the 2020 census. Perhaps even new OZs could be designated to replace any that no longer meet the criteria. This would likely have to be combined with the “Grandfathering” rule as well, or else in-process projects with existing investors could get kicked out. This would permit the OZ program to remain true to the original policy goals of the program, by permitting tax benefits only for investments in areas that truly need those investment dollars.

It is too soon to know how the Biden administration is going to tackle this issue. During the campaign last summer, President Biden’s campaign indicated a desire to reform the OZ program, so the outcome to this issue may give us a sense of how he intends to implement his desired changes.

Those of us in the Land of OZ just hope we get an answer soon, since any uncertainty regarding the boundaries of the OZs themselves is going to hamper the OZ program and limit investment.

*Millett thanks Stephen Land and Rachel Flaschner for their helpful comments to this article.

Powered by Froala Editor