Potential changes to the rules for Opportunity Zones could soon allow some foreign investors to reap major tax benefits from the program.
The Internal Revenue Service is considering new rules pertaining to foreign investors’ ability to defer capital gains in the Opportunity Zones program. The new regulations could be released in December, according to the White House Office of Management and Budget. The extent of the changes is unclear, but experts predict they will be geared toward giving foreign investors more clarity on their tax liabilities.
Bloomberg Tax first reported the news.
Both Democrats and Republicans have been targeting Opportunity Zones. President Donald Trump claims the initiative has helped uplift Black and Latino communities, while Democratic presidential candidate Joe Biden said he wants to reform the program to ensure it’s being used to help distressed areas.
The program allows developers and property owners to defer or forgo paying capital gains taxes if they invest in one of the 8,700 Opportunity Zone sites throughout the country. After 10 years, an investor or developer can forgo their entire capital gains taxes on their Opportunity Zone investment.
Investors have poured at least $10 billion into Opportunity Zones funds as of March, according to an analysis by accounting firm Novogradac, based on over 600 Opportunity Zones funds tracked. Initially, the government projected that $100 billion of investments would flow into these zones.
The potential rule change comes at a time when some countries are looking to take advantage of low interest rates in the U.S. and invest in commercial real estate. While overall foreign investment dropped by 46 percent to $42.8 billion between July 2019 and June 2020, South Korean investment rose 230 percent to $3.6 billion, according to Real Capital Analytics.
It seems unlikely, however, that any change targeted at foreign investors would have an outsized impact on the program. Only foreign investors — including individual investors or eligible businesses — with capital gains from selling a U.S. business or piece of real estate would qualify. Tax-exempt institutional investors, such as pension funds and endowments, are not eligible.
Foreign investors aren’t currently excluded from participating in Opportunity Zones projects, but there is some uncertainty over how they would be taxed and whether or not they could withhold capital gains, according to Daniel Ryan, a partner at the law firm Sullivan & Worcester in Boston, who is a member of the firm’s Opportunity Zones practice.
“It would be helpful for fund managers [to get more clarity] because they would know what obligations they would have,” said Ryan.
Reid Thomas, chief revenue officer of NES Financial, said his firm has seen very little Opportunity Zone interest from foreign investors. He noted that the Trump administration may be looking for ways to infuse the program with more capital during the remainder of the president’s term.
“The country needs stimulus, and things like Opportunity Zones are a lot less expensive than writing stimulus checks,” said Thomas.
When the program was first enacted in 2017, developers were emphatic that its generous tax breaks would be a windfall for the industry. But enthusiasm dampened when land prices in Opportunity Zones skyrocketed, narrowing the returns for investors. Other developers found it difficult to find projects in low-income or transitional neighborhoods that would pencil out.
A recent study by the Urban Institute also found that the program has not incentivized investors to invest in distressed areas. Instead, it has largely benefited real estate developers who would be building projects in Opportunity Zones even without the added tax breaks.