Since Opportunity Zones were first authorized in December 2017 as part of the Tax Cut and Jobs Act, there has been significant discussion about how to best utilize these opportunities and obtain the resulting tax benefits. The first wave of Opportunity Zone projects consisted primarily of traditional real estate development, in part because the constituent parties were uncertain as to how the Internal Revenue Service would implement this new regime with respect to operating businesses. It did not hurt that many of these initial real estate development projects were “shovel ready,” with the Opportunity Zone tax incentive supplementing ongoing efforts to get the shovels in the ground.
While real estate development will always present a navigable framework for Opportunity Zone investments, the Opportunity Zone legislation and associated regulations provide multiple avenues to invest in non-real estate business ventures that might, in fact, yield the greatest potential upside and resulting tax savings for investors. The authors and supporters of the Opportunity Zone legislation specifically sought to incentivize investors to deploy their capital gains to operate businesses that would result in the growth of such businesses and consequently the revitalization of the communities in which those businesses are located.
Start-Ups and New Businesses
The champions of the Opportunity Zone legislation emphasized investment in start-up businesses as a primary focus of the legislation. The belief was that by unlocking capital investment in start-ups located within Opportunity Zones, these businesses could leverage capital that might not have otherwise been available to them into growth and expansion, with that growth and expansion resulting in a transformative impact to communities located within and near the Opportunity Zones
Correspondingly, the main tax benefit for Opportunity Zone investors is that any appreciation on their investment is generally tax free so long as the investment is held for at least ten years. Just imagine if the next Facebook locates its business in an Opportunity Zone. Investors could expect to realize the substantial gains on that investment tax-free because of the Opportunity Zone legislation. Meanwhile, the community within the Opportunity Zone should be the beneficiary of the job creation, infrastructure construction and development of other new businesses and community amenities.
While there are potentially significant benefits of investing in a start-up located in an Opportunity Zone, careful attention must be paid to ensuring the business is structured and maintained in a way to ensure it qualifies as a Qualified Opportunity Zone Business. Among other requirements, substantially all of the start-up company’s assets must be acquired after December 31, 2017. Additionally, the start-up business must ensure that a sufficient portion of the business’s operations take place within the Opportunity Zone. The regulations issued by the Internal Revenue Service have established a framework for satisfying all of the applicable requirements, but investors and businesses should consult with their advisors to understand how to comply with that framework.
Business Expansion and New Facilities
Although it may be more difficult for existing business to easily qualify as a Qualified Opportunity Zone Business for potential investors, there are avenues for investment that are available within the Opportunity Zone regulatory framework. For example, if a business needs to expand or build a new facility, proper structuring of such facilities could allow for Opportunity Zone investment if such facilities were located in an Opportunity Zone. Depending upon the financial circumstances and the availability of capital gains to invest, the funding could come from either existing investors of the business (or potentially even the business itself), outside third-parties to the extent the company is looking for additional capital sources or a combination of both. By strategically thinking about expansion, the business and related investors could turn a business need into a potential investment with long-term tax benefits.
These examples demonstrate just a few ways businesses can take advantage of the Opportunity Zone initiative beyond traditional real estate development, which has dominated headlines to date. With diligent planning and the assistance of experienced counsel, investors and the companies in which they invest can realize the myriad of benefits generated by Opportunity Zones.
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Please contact Matt Ehinger, Jay Augustyn, Josh Schlake or anyone on the Opportunity Zone Team with any questions you have with respect to Opportunity Zone investments or general Opportunity Zone framework.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.