Qualified Opportunity Zones - How Active Participation and Complementary Legislation Can Help States Develop Their Distressed Communities

• Author: Michael Neiman
• Position: J.D., May 2019, Capital University Law School; Volume 47 Staff Member, Capital University Law Review; B.S. Corporate Finance, December 2015; The Ohio State University
• Pages: 173-202

QUALIFIED OPPORTUNITY ZONES—HOW ACTIVE PARTICIPATION AND COMPLEMENTARY LEGISLATION CAN HELP STATES DEVELOP THEIR DISTRESSED COMMUNITIES MICHAEL NEIMAN * I. I NTRODUCTION This comment recommends a legislative proposal for states to enact a complementary law to the Qualified Opportunity Zones (“Opportunity Zones”) tax incentives that were granted by the Tax Cuts and Jobs Act (“TCJA”) in December of 2017. The driver behind this tax incentive was the focus on “addressing the impact of the uneven economic recovery” after the 2008 housing market crisis. 1 The expectation is that this program would “encourage long-term private capital investment” into these economically distressed areas to make up for the slow rate of recovery of the areas following the recession. 2 The goals of this tax incentive cannot be maximized without the ongoing interaction with state governments, who are most familiar with their communities. 3 By enacting a complementary state tax law and being an active participant through endorsing opportunity plans, states will be able to “realize the full economic and social potential of this * J.D., May 2019, Capital University Law School; Volume 47 Staff Member, Capital University Law Review; B.S. Corporate Finance, December 2015; The Ohio State University. I would like to thank all of the staff and students at Capital Law School for constantly pushing me to be a stronger legal professional. I would also like to thank Sikora Law LLC for sparking my interest in this particular topic, our clients for entrusting us with this work, and Professor Richard J. Wood for guiding me through the drafting of this comment. 1 JARED BERNSTEIN & KEVIN A. HASSETT, UNLOCKING PRIVATE CAPITAL TO FACILITATE ECONOMIC GROWTH IN DISTRESSED AREAS 1 (2015), https://eig.org/wpcontent/uploads/2015/04/Unlocking-Private-Capital-to-Facilitate-Growth.pdf [https://perma .cc/4582-VZRF]. 2 Benjamin W. Kennedy, The Opportunity Zone Program , 26 NEV. LAW. 19, 19 (2018). 3 BRUCE KATZ, JEREMY NOWAK, JAMIE RUBIN & DAN BERKOVITS, HOW STATES CAN MAXIMIZE OPPORTUNITY ZONES: THE GOVERNANCE PROJECT 2 (2018), http://thenewlocalism.com/wp-content/uploads/2018/06/OpportunityZonesStateActionPlan _TheNewLocalism_June222018.pdf [https://perma.cc/D96L-K59Z] (“States can play multiple roles to enhance the attractiveness of Opportunity Zones and ensure that social benefit within and beyond these communities are maximized.”). 458 CAPITAL UNIVERSITY LAW REVIEW [48:457 unique tax incentive.” 4 One major concern behind this tax incentive is the effect it will have on affordable housing in these distressed communities, 5 which are already at risk of being subjected to gentrification. 6 Enacting a state income tax credit would encourage more local money to pour into the Opportunity Zones, and limit the amount of out-of-state capital coming in. 7 Local investors presumably have the best intentions of growing their local distressed economy in a way that is most sensible, since it will be close to home. These investors are not just making an investment, receiving an economic return, and never seeing the results; these results are in their backyard, giving the investors the opportunity to personally interact with them. This comment will review the background and policy of Opportunity Zone law, the mechanics of the tax incentive given the recently released sets of Proposed Regulations, and the benefits investors can expect. After reviewing that information, this comment will discuss complementary bills introduced at the state level and look at suggestions on how state bills introduced in the future could be improved to achieve the policy and purpose behind the Opportunity Zone incentive and maximize value within these distressed communities. 4 Id. 5 Id. at 14 (“Expanding the production and preservation of affordable housing is a key component of a successful Opportunity Zone strategy. Concerns have been raised that increasing market investment in low-income communities will boost housing prices and displace the very residents that the tax incentive is intended to help.”). 6 Sue Sturgis, New ‘Opportunity Zone’ Program Risks Gentrifying Distressed Communities , FACING SOUTH (Mar. 9, 2018), https://www.facingsouth.org/2018/03/new-opportunity-zone-program-risks-gentrifying-distressed-communities [https://perma.cc/ SGD9-NSZG] (“[D]epending on how the funds operate, the program could end up serving as a tax subsidy for gentrification—the largely urban phenomenon in which affluent people move into predominantly poor communities, causing jumps in housing prices that can displace longtime residents.”). 7 NORTON FRANCIS, STATE TAX INCENTIVES FOR ECONOMIC DEVELOPMENT 3 (2016), https://www.urban.org/sites/default/files/publication/78206/2000636-state-tax-incentives-for-economic-development.pdf [https://perma.cc/U498-RZCR] (“The idea is that significant tax incentives will increase investment in a geographic area and thus lead to more jobs and a revitalized community.”). 2020] QUALIFIED OPPORTUNITY ZONES 459 II. B ACKGROUND The TCJA of 2017 established an Opportunity Zone tax incentive program, which, “[i]n short . . . us[es] tax law to promote private sector equity investment in certain geographically defined distressed communities.” 8 This rare bipartisan bill satisfied republican interests through tax incentives to private investors while also satisfying a typical democratic interest by encouraging investment into “economically distressed communities . . . .” 9 This bill brought together “a regionally and politically diverse coalition of nearly 100 cosponsors to support and promote the idea” that idle “capital could be put to work in rebuilding our urban neighborhoods, family farms, and local businesses[.]” 10 Following the crisis, “certain areas of the country [were] doing remarkably well,” some even “exceeding their pre-recession economic states.” 11 However, this recovery was unbalanced; while some areas thrived, others faced “chronic rates of long-term unemployment and historically low levels of new investment.” 12 A study by the Economic Innovation Group created a “Distressed Community Index” by looking at the following seven factors to determine the economic well-being of areas determined by zip codes: (1) high school diploma rate; (2) housing vacancy rate; (3) percentage of adults not working; (4) poverty rate; (5) median income ratio; (6) change in employment; and (7) change in business establishments. 13 This study concluded that the imbalance in recovery was directly related to distressed geographical areas, 14 and while “prosperous zip codes enjoyed widespread job and business growth during the recovery,” the “majority of distressed zip codes contended with stagnation or decline.” 15 “The proliferation of severely distressed areas around the county has been a 8 Michael Novogradac, Scott Keller, Peter Lawrence & Mark Shelburne, Tax Reform & Its Consequences for Affordable Rental Housing , 27 J. AFFORDABLE HOUSING & COMMUNITY DEV. L. 107, 118–19 (2018). 9 Diane Lupke, Opportunity Zones: A Different Zone Opportunity , 28 J. MULTISTATE TAX’N & INCENTIVES 24, 24 (2019). 10 Id. 11 BERNSTEIN & HASSETT, supra note 1, at 2. 12 Id. 13 ECON. INNOVATION GRP., THE 2017 DISTRESSED COMMUNITIES INDEX 6–7 (2017), https://eig.org/wp-content/uploads/2017/09/2017-Distressed-Communities-Index.pdf [https://perma.cc/QWB3-X38U]. 14 BERNSTEIN & HASSETT, supra note 1, at 2. 15 ECON. INNOVATION GRP., supra note 13, at 15. 460 CAPITAL UNIVERSITY LAW REVIEW [48:457 drag on the overall health of the U.S. economy and the pace of the economic recovery.” 16 When the Investing in Opportunity Act . . . was first introduced in Congress in 2016, the [Economic Innovation Group] conducted an analysis of the Federal Reserve’s Survey of Consumer Finances and Financial Accounts of the United States to calculate that U.S. households were sitting on $2.3 trillion dollars in unrealized capital gains in stocks and funds alone at the end of 2015. 17 By the time the tax incentive was implemented at the end of 2017, that unrealized capital gain figure grew to $3.8 trillion following a long and successive stock market expansion. 18 Consequently, including U.S. corporations’ estimated $2.3 trillion dollars in unrealized capital gains, “the pot of potential capital eligible for reinvestment in Opportunity Zones climbs to a total of $6.1 trillion.” 19 Ultimately, when it comes to making investments in these historically disadvantaged communities, “[t]here is not a lack of capital but rather a lack of connectivity and a lack of techniques to convert market power into tangible resources.” 20 This is the over-arching goal of the Opportunity Zone law, to connect these communities to a large influx of investment capital that is sitting on the sidelines. III. M ECHANICS OF THE I NCENTIVE Two of the provisions included in the TCJA created this new tax incentive known as Opportunity Zones. 21 First, section 1400Z-1 of the Internal Revenue Code (“IRC”) “created a procedure for identifying Opportunity Zones.” 22 Second, section 1400Z-2 of the IRC introduced the 16 BERNSTEIN & HASSETT, supra note 1, at 4. 17 Opportunity Zones: Tapping Into a $6 Trillion Market , ECON. INNOVATION GRP. (Mar. 21, 2018), https://eig.org/news/opportunity-zones-tapping-6-trillion-market [https://perma. cc/2F9N-9GBF]. 18 Id. 19 Id. 20 BRUCE KATZ & JEREMY NOWAK, THE NEW LOCALISM: HOW CITIES CAN THRIVE IN THE AGE OF POPULISM 245 (2017). 21 Steven Berman & Louis Weller, Opportunity Zone Investments: The New Emerald City of Tax Law , 130 J. TAX’N 6, 6 (2019). 22 Id. 2020] QUALIFIED OPPORTUNITY ZONES 461 tax benefits and governing rules associated with investing in an Opportunity Zone, as identified by 1400Z-1. 23 A. Qualified Opportunity Zones (“Opportunity Zones”) An Opportunity Zone is defined as “a population census tract that is a low-income community that is designated as a qualified opportunity zone.” 24 The selection of Opportunity Zones “is based...