Brownfield Listings: Projects Must Still Pencil in Opportunity Zones
By Barry Hersh, Vita Nuova Member and Clinical Associate Professor, NYU SPS Schack Institute of Real Estate.
Opportunity Zones (OZs) are a hot topic. The concept of providing a tax benefit that increases investment in low income communities has excited many redevelopers, financiers and community advocates. OZ funding carries with it lots of potential advantages but little oversight and therefore much risk. Tax incentives only function and result in community improvement and investor returns when the underlying real estate development or transaction makes sense and results in a return on investment.
The bottom line? The project still has to pencil.
This article will examine the nature and risks of OZs in relation to past efforts to use tax law, primarily federal income taxes, to encourage desirable real estate investment, with mixed results.
It is important to note at the beginning that despite their broadly stated intentions, the OZ regulations and criteria make no requirement of specific community benefits, environmental remediation, affordable housing, historic preservation, sustainability or otherwise. A project is either sufficiently (70%) in the zone and eligible, or not.
The hard and fast rules have drawn calls for added flexibility. The U.S. EPA Office of Brownfields and Land Revitalization (OBLR), for example, in a carefully crafted letter sent to Treasury on December 18, 2018, proposes some important suggestions to make the OZ regulations more supportive of brownfields redevelopment. These recommendations include; clarifying that remediation falls under the definition of “original use”; that remediation costs are an eligible capital investment in Qualified Opportunity Funds and providing enough time for remediation and redevelopment. These recommendations are needed to help match the realities of brownfield redevelopment work in OZs to the structure of the OZ framework, so as not to exclude the large amount of impacted and brownfield land in these areas.
Compared to existing law, the closest model to OZs is the existing 1031 exchange statute which has long been a tool to defer capital gains taxes. Begun close to a hundred years ago, tax deferred exchange rules have been revised numerous times, including last year’s modification to become limited to non-residential real estate. Notwithstanding its difficulty and limitations, the 1031 exchange program remains widely used in commercial real estate transactions.
OZ investments, like 1031 exchanges, do provide for deferment of capital gains on properties when the sale proceeds are directly invested into eligible property; but OZs go further by eliminating the capital gain if the OZ investment remains in place for more than ten years. 1031 exchanges have proven a valuable but demanding tool, those investors looking to sell while deferring capital gains tax must select a “like-kind” property within strict time restrictions, and are often seen as paying a premium for qualifying property, exceeding the market. If that price is too high, or the newly acquired property does not perform to expectation, whatever benefit gained by deferring capital gain taxes, losses can readily exceed the tax benefits.