November 26, 2018

The door widens to 'Opportunity Zones' amid concerns about impact

Photo | HBJ File
Photo | HBJ File
The intersection of Jefferson and Washington streets, near Hartford Hospital, could benefit from new development because it's located within an Opportunity Zone.
John F. Stafstrom Jr., Chair, Public Finance Department, Pullman & Comley LLC
Elizabeth “Liddy” Karter, Managing Director, Enhanced Capital Partners LLC
Catherine Smith, Commissioner, Department of Economic and Community Development
Brian Newman, Partner, CohnReznick LLP

What is an Opportunity Zone?

An Opportunity Zone is an economically distressed community where new investments may be eligible for preferential tax treatment. They are designed to spur economic development by providing tax benefits to investors in the form of capital gains deferrals.

First, investors can defer tax on any prior gains invested in a qualified opportunity fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or Dec. 31, 2026.

If the QOF investment is held for longer than five years, there is a 10 percent exclusion of the deferred gain. If held for more than seven years, the 10 percent becomes 15 percent.

Second, if the investor holds the investment in the opportunity fund for at least 10 years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.

Source: IRS

Opportunity Zones (OZs), created in the last year to leverage tax-deferred investments to spur realty- and business-development in the U.S.' neediest communities, could soon explode onto the scene now that the federal government has issued draft regulations.

Besides investors, anticipated beneficiaries are the 72 low-income neighborhoods in 27 municipalities across Connecticut that have been tagged as OZs. That includes 10 zones in Hartford's Parkville, Upper Albany and other neighborhoods that could jumpstart development beyond downtown, which has been the locus of most investment in recent years. Other OZs exist in West Hartford, East Hartford, Bristol, Middletown, Meriden and Manchester.

Some tax lawyers and certified public accountants say they are already hearing from potentially eligible wealthy individuals, corporations, partnerships, trusts, estates and developers eager to use the newest government-sanctioned vehicle for shielding some or all of investors' capital gains from federal taxation.

Some firms are even beefing up staffing to meet expected demand. Hartford law firm Shipman & Goodwin just announced the launch of an OZ team. Moreover, major Hartford employers, including The Hartford, Aetna, Hartford Hospital, St. Francis Hospital and Medical Center and Trinity College, are located within or near an OZ and could be catalysts for some development.

The U.S. Treasury Department and Internal Revenue Service released the new OZ draft guidelines in October and are encouraging investment to begin immediately.

One estimate is that as much as $6 billion of eligible capital gains could be invested in OZs.

"Everybody thinks the reaction to Opportunity Zones will be great,'' says attorney John F. Stafstrom Jr., head of the public finance department at Connecticut law firm Pullman & Comley LLC.

Hartford Mayor Luke Bronin says the city has been in touch with investors, whom he declined to name, "who see the potential opportunity in Hartford." Each of the city's 10 OZs harbor realty projects that already are in various stages of development, and are ripe for OZ funding, he said.

"We've worked very hard to accelerate growth and [OZs are] an important new tool in our toolbox,'' Bronin said.

Some Hartford area commercial developers say they are eyeing closely developments unfolding around OZs and OZ funds, but have not yet moved to take advantage of them.

Elizabeth "Liddy" Karter, managing director of Enhanced Capital Partners LLC in Stamford, said she is assembling a fund to pursue OZ investments. Her firm, which funds preservation and redevelopment of historic properties nationwide into housing, and provides capital to small businesses and for sustainable-energy projects, is bullish about its prospects.

"We like the focus of trying to invest in underserved communities,'' she said.

But some OZ proponents fret that real-estate development, rather than financing small or startup businesses, which is permissible under OZ rules, will be the primary focus for investors. In particular, some see the requirement that to qualify for OZ investment, a firm must do at least 70 percent of its business in its home community as a steep hurdle.

Catherine Smith, commissioner of the state Department of Economic and Community Development, is among those harboring concerns.

"There's no doubt it's extremely attractive for a real-estate investment,'' she said.

Earlier this year, Smith said she and fellow economic-development chiefs in a dozen other states jointly wrote to Treasury officials, urging they draft rules that would be as "friendly as possible to business startups.''

"There's a ways to go before it's really as good for the entrepreneur as it is for the real-estate developer,'' she said.

Another tough OZ provision, experts say, mandates that, in order for investors to reap the maximum tax benefit from their OZ investment, they must wait as long as 10 years to recover at least their initial stakes.

Under rules co-drafted by the IRS, and open for public comment through the end of the year, OZ funds that invest in eligible enterprises must do so via an equity stake, not a loan.

Certified public accountant Brian D. Newman, partner and office department head at CohnReznick LLP, says Treasury will likely issue more clarifications of OZ rules in coming weeks as they collect and analyze public feedback.

One rule as proposed, he said, gives OZ funds up to 31 months to put their working capital into qualified OZ businesses, as long as the funds have a written action plan or schedule for applying the capital.

Meanwhile, DECD's Smith says her agency is committed to educating potential investors, developers and others about the benefits of OZs and OZ funds. Staff is creating a website devoted to OZs, featuring a map identifying each OZ in the state, plus other useful information.

DECD staff, too, are working with economic-development officials in OZ-designated communities to identify "the best, shovel-ready projects,'' the commissioner said.

For more information about Connecticut "Opportunity Zones," contact DECD's Maya Loewenberg at 860-500-2455.

CORRECTION: Shipman & Goodwin has launched a multi-lawyer team to oversee its opportunity zone practice. A previous version misstated the number of attorneys assigned.

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