Opportunity Zones: A Potential New Source of Affordable Capital for EB-5 Projects
- Posted: April 16, 2019
- Posted by: Travis Lynk
- Last Reviewed: April 16, 2019
The EB-5 Immigrant Investor Program was designed to stimulate the economy through the infusion of foreign capital tied specifically to job creation. The 2017 Tax Cuts and Jobs Act may provide a new source of EB-5 capital for developers. The Investing in Opportunity Act (IIOA) creates a mechanism for investors to defer and/or reduce capital gains taxes by rolling those funds into economic development projects in Opportunity Zones. As the EB-5 and Opportunity Zone programs share similar goals, EB-5 fund managers and developers are uniquely positioned to pivot to this new source of funding.
By some estimates, there is over $6 trillion in unrealized capital gains available in the market, potentially making the IIOA the largest economic development program in U.S. history.
What are Opportunity Zones?
Opportunity Zones are economically distressed census tracts identified by state and territorial governors and certified by the U.S. Treasury Department. There are 8,700 certified Opportunity Zones, located in 50 states, the District of Columbia, and five U.S. territories, comprising roughly 12% of all U.S. census tracts.
Investors who realize capital gains can invest the money in Opportunity Funds and stand to reap the following tax benefits:
- A deferral of capital gains tax payment until 2026, or until the property is sold, whichever comes first
- A 10% reduction in tax liability if the investment is held for five years, with an additional 5% in step-up basis, for a total of 15%, if the property is held for seven years
- No capital gains tax liability on any investment held for 10 years or more
To qualify for the tax deferment and reduction, at least 90% of the Opportunity Fund’s capital must be invested in Opportunity Zone projects, either in businesses or real estate. Real estate projects can take the form of new construction or renovation of existing structures, but work must be completed within 30 months. In the case of renovations, the cost of improvements must be equal to or greater than the purchase price of the asset.
Opportunity Zone property must be acquired after December 31, 2017, to qualify, which may slightly limit initial synergy between the EB-5 program and Opportunity Zone capital. However, EB-5 developers may be able to repackage and spin off portions of existing projects for Opportunity Zone funding and still keep up to a 20% stake in the repackaged project.
How does the EB-5 program align with Opportunity Zones?
Both programs were created to spur economic development in distressed areas. The EB-5 program’s targeted employment areas are similar in nature to the IIOA’s Opportunity Zones, suggesting potential overlap between the two. Existing EB-5 projects may qualify for Opportunity Zone funding.
In addition, both programs aim to reduce the cost of capital for developers through targeted benefits. In the case of the EB-5 program, benefits are primarily aimed at immigration, while Opportunity Zone benefits tilt toward reducing tax exposure. Because return on investment is likely a secondary consideration for investors in both programs, there is more flexibility to fund different types of projects.
Finally, both programs favor long-term investment. Opportunity Fund investors are rewarded with greater benefits the longer they hold their investments and must hold them for 10 years to reap the maximum tax benefits. Opportunity Zone capital is patient and focused on the same type of real estate projects that typically attract EB-5 investors.
Who oversees the Opportunity Zone program?
While USCIS provides management and oversight of the EB-5 program, the Section 1400Z statute of the U.S. Tax Code regulates capital gains invested in Opportunity Zones. Compliance and reporting requirements will be developed and enforced by the IRS.
Beyond that, there is little federal or state oversight of Opportunity Zone investments. Individual investors and Opportunity Funds self-certify under existing IRS guidelines and establish their own development priorities.
In simple terms, the EB-5 program involves private equity investments with immigration benefits, while Opportunity Zone investments are private equity with tax benefits. The overlap between the two programs may provide a welcome source of new capital for EB-5 projects.