The CEO of a startup wears many hats-inspiring leader, team and talent builder, prime marketer-but financing is the foremost responsibility. Talented people must be properly compensated, equipment purchased, and bills paid. The 2017 federal Opportunity Zone legislation created a new, and potentially rich, source for startup financing.
Opportunity Zones: Purpose and Definition
The 2017 Tax Cuts and Jobs Act (Public Law No. 115-97) created Opportunity Zones (OZs). OZs are a new economic redevelopment concept created by Congress which incentivizes investment in businesses and/or real estate located in economically distressed areas. These areas have lower incomes and higher unemployment.
The purpose behind the legislation is to encourage economic growth and job creation in underserved communities by offering significant tax benefits to investors to place their money there. Opportunity Zone (OZ) investments are made via a Qualified Opportunity Zone Fund (QOF).
State governors designate those census tracts that qualify as “low-income communities” under the federal income tax code, and when these designations receive federal approval, these tracts become part of the OZ program. Over 8,700 official OZs are in the 50 States, Washington, D.C. and U.S. territories. A map of Opportunity Zones may be found here.
QOF: The Vehicle for Opportunity Zone Investments
A QOF is an investment vehicle that has at least 90% of its assets as “Qualified Property” (QP). QP is either tangible property in an OZ, or equity interests in a U.S. company that is engaged in a qualified opportunity zone business. While the OZ legislation initially attracted real estate investors, subsequent IRS guidance has gotten the attention of investors willing to finance existing or startup businesses.
Note that because this is a federal program, there arise legal and tax issues that require professional help.
The local economy will benefit directly in terms of job creation, and indirectly by increased economic activity, wealth, and expanded tax base. Many QOFs invest in and rehabilitate vacant or dilapidated real estate, which addresses one of the many quality of life issues that plague urban areas.
The legislation provides for three significant federal income tax benefits to OZ investors.
· Temporary deferral of tax on realized capital gains reinvested in a QOF. These gains might arise from stock or real estate sales. These reinvested capital gains are not taxed until the end of 2026 or when the QOF asset is sold, whichever is earlier.
· Basis step-up for capital gains reinvested. The effect of the basis step-up is to reduce the amount of the gain by 10% for capital left in the QOF for at least five years, and a 15% reduction in the gain for capital invested in the QOF for at least seven years.
· Permanent exclusion from income tax for capital gains arising from the sale of QOF property for investments held for at least 10 years.
Most urban areas direly need jobs and revitalization, and OZs are a tool for investors to improve the lives of others in a tax-advantaged manner. The Opportunity Zone legislation is an example of rational government action. By offering investor tax benefits, private sector capital and entrepreneurs are attracted to areas sorely in need of new investment, jobs, and economic revitalization. Startup CEOs should consider OZ locations both for the chance to do good while expanding their pool of financing sources.