The U.S. Department of the Treasury released its latest set of regulatory guidelines on opportunity zones on Wednesday, offering significantly more clarity about the program, which provides tax incentives to developers entering geographic areas slated for improvement. Real estate investors appear to be getting everything they want from the program.
The new guidelines address a number of real estate-related concerns, such as how multi-asset funds and REITs can be exited, flexibility in making investments and reinvesting within a fund, the treatment of debt-financed distributions, and the handling of both improved and unimproved land. REITS, multi-asset funds and single asset investments all appear to work within the structure of the program.
Real estate investors appear to be getting everything they want from the program.
As a result, we expect the already frothy real estate market to accelerate deal flow and drive investment over the next two to three years.
Operating businesses also received a significant amount of attention after being neglected in the previous guidance. The most critical clarification addressed the 50 percent revenue requirement, which will be tied to employee hours, employee salaries or, effectively, a company’s headquarters location. Given the examples the IRS used for the first two measurements—a tech company and a service company—it’s clear the government sees most job growth in the U.S. economy being driven by these sectors.
The examples helped to explain how these types of companies could leverage the program’s employee requirements to drive growth in economically depressed areas. It is notable that the headquarters example was of a landscaping company, a type of business not likely to be a big driver of economic growth. The headquarters rule appears to provide the most leeway for companies to meet the 50 percent revenue requirement. Given its flexibility, this provision could be open to abuse by taxpayers with investments that do not drive the level of economic growth in a census tract expected by politicians sanctioning the project.
The biggest concerns holding back the program now will be economically driven, as land prices (particularly those in opportunity zones) and the lack or cost of labor will create headwinds for the program and dilute the tax benefits. The IRS is attempting to exclude capital gains that would arise during the 10-year hold period for investments, but it is struggling to find a legal way to make this happen.
Overall, the new revenue guidance—along with comments on how leases and leased equipment will be treated by the program—has cleared the way for businesses and investors to invest in opportunity zones and drive the economic growth that regulators desire.
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