A Window of Opportunity for Opportunity Zone Investors
By Valerie Grunduski
Five years after Congress created the Opportunity Zone (OZ) program as a way to channel investment dollars to areas in need, Congress is set to modify the program to work more in line with its original intent. .
This could be great news for current and potential investors, especially those who care about the positive effect their businesses have on society. But before discussing why investors should care, it’s important to understand the two main shortcomings that precipitated the changes to come.
The first is essentially bureaucratic. The Opportunity Zones program got off to a slow start, partly due to delays in Treasury forecasts. Now, the current 2026 deadline for investors to defer capital gains tax is fast approaching, giving them less and less incentive to participate.
The second problem is more fundamental: due to a lack of reporting requirements in the original law, there is not enough data available to measure the impact of the program on objectives such as job creation and business growth in low-income areas. A report by the Urban Institute found that most of the money invested under the program was funneled into real estate projects rather than the small businesses it was intended to support. Since the nearly 9,000 OZs selected under the program were based on 2010 census data, some of the areas had already become more economically vibrant in 2020, but were still receiving investment.
A New and Improved Plan
The good news is that the OZ program is about to get a second life. A group of senators tabled a bill in April it would make significant changes to the program and has a good chance of being approved given strong bipartisan support on the issue.
The main proposed reforms are as follows:
- Extend capital gains tax deferral period by two years to 2028
- Impose more detailed reporting requirements on Qualified Opportunity Funds (the entities that absorb OZ investments) to improve transparency and impact
- Allow for tiered structures so these funds can invest in other funds within the program
- Temporize certain AOs and allow states to replace them with plots in the most needy communities
What does all this mean for investors?
The two-year extension of the capital gains tax deferral is a clear incentive improvement: it will make funds more attractive by increasing the time for potential investors to make a qualified investment. Additionally, by deferring their tax payment to 2028, investors could still be eligible for the partial base increase that expired in 2019 and would reduce their tax liability. They are also still eligible to pay no capital gains tax on any profit on the investment when they sell it after a 10-year holding period and may benefit more from depreciation along the way.
The decision to refocus the program on its goal of benefiting low-income areas also has implications for investors. The bill requires funds to file an annual report with more detailed information than before, including the impact of investments on business development and job creation.
This means funds may have to work harder and hire additional people or service providers to meet reporting requirements. The stricter compliance rules could discourage some investors who had viewed the program purely for profit maximization and tax avoidance. On the other hand, it will make OZs more attractive to the growing ranks of investors eager to make a social impact and who may have been left on the sidelines until now.
What about ESG?
The stricter requirements and increased focus on social impact could also make it easier to classify OZ investments as ESG-compliant. Investors will be able to quiz funds on how they meet the new criteria and request data to back it up.
Allowing a tiered funding structure should expand investment opportunities for larger players. In the previous structure, it might not have made sense for a large institutional investor to support a relatively small project. A tiered fund would allow them to spread a larger amount over several smaller projects.
The designation of new AOs under the law will also create opportunities. Investors can even approach state authorities to encourage the inclusion of deserving areas that have growth potential. At the same time, previously neglected AOs could become more attractive investment targets under the new standards.
Investors should also watch closely for additional financial incentives that states may provide to supplement the federal program, which several states, like Ohio, have already done so under the existing OZ initiative. At the other end of the spectrum, California does not allow federal incentives to apply to state taxes.
Overall, the new bill is a welcome update that has the potential to reinvigorate the OZ program, creating better alignment with its social goals while offering attractive tax savings and growth potential for investors.
About the Author: Valerie Grunduski
As a real estate tax specialist at Plante Moran, Valerie Grunduski advises clients on planning issues related to purchases and sales, partner takeovers and takeovers, tax and debt structuring, historical tax credits and other community development incentives. Additionally, she consults with clients on how best to utilize the Opportunity Zone incentive. As a leader of this investment vehicle, Valerie works with those seeking to create Opportunity Zone Funds and is involved in a coalition to help policy makers shape regulations and legislative corrections. To learn more, visit plantmoran.com.
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