Editorial · September 9, 2018
Opportunity Zones: What Small Businesses Need to Know
Opportunity zones are low-income areas where new investment can earn special tax treatment under a law signed in December 2017. The idea is simple. Investors who sell something at a profit can put that profit into a fund that invests in these areas. In return, they can delay the tax bill and may owe less in the end. For a small business, the point is that more outside money may now look at your neighborhood.
What opportunity zones are
An opportunity zone is a census tract that a state nominated and the U.S. Treasury approved. The Tax Cuts and Jobs Act, Public Law 115-97, created the idea. Each state, the District of Columbia and the U.S. possessions picked low-income tracts to put forward.
On June 14, 2018, Treasury and the IRS announced the last round of approvals. The program now covers all 50 states, the District of Columbia and five U.S. possessions. Treasury says nearly 35 million Americans live in the chosen tracts. The average poverty rate in them is over 32 percent, compared with 17 percent for the average tract. A zone keeps its label for 10 years.
How the tax benefit works
The benefit is meant for people with capital gains. A capital gain is the profit from selling stock, a building or another asset. Under the law, a seller can leave that gain out of income for now if they invest the same amount in a Qualified Opportunity Fund within 180 days of the sale.
The law then gives three possible rewards for staying invested:
- The tax on the old gain is put off until the investment is sold, or until December 31, 2026, whichever comes first.
- After 5 years, the investor's tax basis goes up by 10 percent of the deferred gain. After 7 years, it goes up by 5 percent more. A higher basis means less taxable gain.
- After 10 years, the investor can ask to set the basis at the fair market value on the sale date. Gains earned inside the fund can then go untaxed.
The investor does not need to live or work in a zone to claim these benefits. They only need to invest through a fund.
What a Qualified Opportunity Fund is
A Qualified Opportunity Fund is a company or partnership set up to invest in property in a zone. By law, it must hold at least 90 percent of its assets in qualified opportunity zone property. The fund is tested twice a year to check this.
The IRS says a fund certifies itself. No one at the IRS approves it first. The owner files a form with a federal tax return. The IRS said in its FAQ that it would release that form in the summer of 2018.
What it may mean for a small business
This is not a grant or a loan program. The government does not pay a business to sit in a zone. The tax break goes to the investor, not to the business owner.
Still, there may be a side benefit. If you run a business inside a zone, a fund may see you as a place to put money. Funds may back new buildings, new space or growing companies there. That could help you find financing that was hard to get before.
Some cautions are fair. The rules are new. Treasury and the IRS said they were still writing guidance on how the funds and their investments will work, and that it was a high priority for the next few months. Details could change what funds can do. Do not make plans that depend on a fund showing up. Talk to a tax adviser or an attorney before you take on any investor who is chasing these tax breaks.
How to find the maps and the list
The CDFI Fund, part of the Treasury Department, keeps a list of all designated zones. It updated the list on June 14, 2018, to show the final designations for every state. It also posts a map. Turn on the Opportunity Zone Tract layer, then zoom in on your area or search by census tract number.
The official list of designated tracts was published in IRS Notice 2018-48, dated July 9, 2018. The CDFI Fund page also links to an IRS revenue procedure that explains how tracts were picked. If your address sits in a listed tract, your business is in an opportunity zone.
Questions to ask before you act
Start by checking your tract on the map. Next, ask whether any fund has shown interest in your area. Then write down what you would do with new capital, so you can explain it clearly. Finally, watch for new IRS guidance. Questions about the tax rules can go to the IRS at the address on the CDFI Fund page.
Opportunity zones are a new tool, and nobody can yet say how much they will change small-business finance. The best step for most owners is to learn the basics now and stay flexible.