As the business landscape continues to evolve, entrepreneurs and business owners are constantly seeking avenues for growth and investment within the state of Alabama and its surrounding regions. One way to capitalize on such investments is through the use of Opportunity Zones – a federal economic development incentive created through Congress’ Tax Cuts and Jobs Act of 2017 (TCJA), which provides tax incentives for the investment of new capital in businesses operating in one or more Opportunity Zones.
Opportunity Zones are generally economically distressed communities in need of investment and revitalization. A community may become a Qualified Opportunity Zone if it was nominated for that designation by a state, the District of Columbia or a U.S. territory, and that nomination was certified by the Secretary of the U.S. Department of Treasury. Under certain conditions, new investments in such communities may be eligible for preferential tax treatment.
Under the TCJA, investors in an Opportunity Zone can postpone taxes on their previously earned capital gains by investing in a Qualified Opportunity Fund (QOF). A QOF is an investment fund – either a partnership or corporation – organized to invest in a Qualified Opportunity Zone property. The deferral of the capital gains invested may last until Dec. 31, 2026, allowing the investor to exclude up to 15% of the deferred gain completely. Additionally, an investor holding investments in a QOF for at least 10 years may be eligible to permanently exclude gains resulting from a qualifying investment when it is sold or exchanged. According to the U.S. Department of Treasury, at least $48 billion of Opportunity Zone equity was invested through 2020.
On Sept. 27, 2023, Representatives Terri Sewell (D-AL), Mike Kelly (R-PA), Daniel Kildee (D-MI) and Carole Miller (R-WV) introduced the Opportunity Zone Improvement Transparency Extension Act (H.R. 5761) (the OZ Act), which is intended to revamp and expand existing incentives around Opportunity Zones.
Modification of Qualified Opportunity Zones
The OZ Act introduces modifications to the Opportunity Zones qualification criteria, specifically targeting census tracts with a high median family income (MFI). Tracts with an MFI exceeding 130% of the national MFI would lose their Opportunity Zone status unless the poverty rate is 30% or higher for non-student populations. Additionally, state executives can request determinations from the Treasury regarding tracts that should retain or lose their Opportunity Zone designation. This process ensures that the zones align with the legislation’s intent to draw capital into underserved and overlooked communities.
Investment Period Extension
One significant amendment proposed by the OZ Act is the extension of the current investment and deferral periods from Dec. 31, 2026 to Dec. 31, 2028. This extension provides investors additional time to plan and execute their investment strategies, aligning with their future strategic goals.
Zero Population Census Tracts
The proposed legislation allows “zero population census tracts” to qualify for designation as an Opportunity Zone, with the goal of encompassing areas that lack population but hold potential for economic revitalization, which often face challenges in securing financing. To meet the criteria, a tract must have zero population, be adjacent to an existing Opportunity Zone on at least one side, have a history of industrial use and include a brownfield site, as determined by the U.S. Environmental Protection Agency or relevant state authority.
Modified Definition of Qualified Opportunity Fund
The legislation introduces the concept of a “feeder fund,” allowing QOFs to invest in other QOFs. This model facilitates collaboration among smaller, regionally focused funds, overcoming challenges associated with scale and giving businesses more flexibility in structuring their investments and raising capital.
Information Reporting Requirements
The OZ Act introduces comprehensive reporting requirements to ensure transparency and accountability. QOFs are mandated to report detailed information, including the number of persons employed through Opportunity Zone investments, providing valuable data on job creation and firm growth.
Investors are also required to report critical information on Opportunity Zone investments, enabling the IRS to track the trajectory of investments over time. These reporting requirements aim to enhance compliance and provide valuable insights for businesses planning their strategic goals.
State and Community Dynamism Fund
The legislation proposes the establishment of a State and Community Dynamism Fund, allocating $1 billion to support public and private investment in Qualified Opportunity Zones. This fund aims to drive capital to underserved businesses and communities, aligning with the broader goal of promoting economic development in these regions.
Funding would be allocated to each state based upon a Treasury-developed formula, taking into account the percentage of prime-age adults without employment in the state compared to the national average. States would then have the authority to distribute funds to local governments and nonprofits. These funds would be targeted toward projects that enhance capabilities in high-poverty, high-need, rural and underbanked communities. Additionally, the funding would seek to boost investment in businesses owned by minorities, women and veterans, propel workforce development in key state sectors and facilitate more affordable housing.
State and local governments can utilize the funding for diverse purposes, including staffing to aid coordination, education and investment endeavors. The funds can also be directed toward community-level capacity building, training, strategic planning and outreach, providing technical assistance and professional services to underserved businesses and QOF managers. The funding is earmarked for predevelopment costs related to Qualified Opportunity Zone projects and mitigating risks for QOFs deploying capital into impactful ventures in high-need industries such as healthcare, social services, healthy food access, education and broadband. Eligible projects extend to investments in small businesses and affordable housing developments. The legislation mandates an annual audit and report from the states to Congress detailing the utilization of these funds.
As businesses look ahead to their 2024 strategic goals, the proposed bipartisan OZ Act emerges as eye-catching legislation that could provide investors with avenues for community investment and sustained tax relief.
Denzel Okinedo is an attorney in the Economic Development Team and Corporate & Tax Practice Group at Burr & Forman LLP in Birmingham, where he regularly assists clients with economic development projects, tax incentives and general corporate/corporate governance matters. The information contained in this article is only provided for informational purposes and should not be construed as legal advice.