Five OZ Dynamics Coming Our Way

Landon Johnson

March 16, 2023

The mission of Opportunity Zones has remained consistent since 2017; help low-income communities access financial, human, and intellectual capital. Yet, the world is very different than it was five years ago when Opportunity Zones were born. Following is an outline of Five dynamics we at CapZone Analytics believe will take root in 2023.

1. New legislation?

There has been much buzz about the Opportunity Zones Transparency, Extension, and Improvement Act. Will it pass? When? Here is what we know: the bill is a bipartisan, bicameral bill championed by US Senators Cory Booker (D-NJ) and Tim Scott (R-SC). The legislation is aimed at adding back the elements of compliance and measurement needed to provide confidence to investors and ensure American communities receive their fair share of the tax break benefits. For more details on the proposed legislation’s components, watch this short video by Al Puchala, CEO of CapZone Impact Investments LLC.

What we don’t know is if this House will be able to get this bill—or any bill—passed. Whether it is in this session, or we have to wait another two years for a shift in power, we remain bullish that some version of this update to the OZ program will ultimately be passed.

2. Welcome institutional investors!

Equity investors have largely been riding the OZ bench, observing the gameplay, and strategizing their entry into the OZ market. In the near term, we will likely see some substantial money flow into the program from institutional investors who have been sidelined since inception, awaiting a final ruling, and riding out the wave of the post-pandemic financial downturn. 

Institutions will be looking for two foundational elements to be in place before making the leap. First, clarity around reporting and compliance. Major players are by nature risk averse, and will look for as much structure and transparency as possible before investing (FWIW, we believe this makes the case for  CapZone Analytics as a standard compliance and reporting platform, but we may be bias). Second, institutions will find attractive the ability to execute a “fund of funds” model enabled by mergers and acquisitions activity. As these two elements become more available, pay attention to the wave of super-OZ funds being formed.

3. Wait, there’s more! Expanding beyond Real Estate

Traditionally, real estate has been a natural investment vehicle because the Opportunity Zone program is location-based, and real estate represents a relatively straight-forward and predictable project in which to invest. According to UC Berkeley researchers, approximately 51% of OZ dollars are invested in real estate firms. In comparison, 9% is invested in construction firms, 9% in finance, 7% in property owned or leased directly by Opportunity Funds, 3% in professional services, and 3% in lodging and restaurants.

However, the OZ program very much applies to a wide variety of investment vehicles, including operating companies. In fact, the case for operating companies is very strong, fueled by the capacity to generate a greater acceleration of profits that can grow tax free.

4. Don’t look now … the IRS is watching 

Expect to see increased Opportunity Zone scrutiny from the IRS. In fact, it has already started happening according to the September TIGTA update which reported that 1,040 QOFs and 5,141 individual tax returns were ‘reviewed’ the previous quarter by the IRS associated to the OZ program. Before you start squirming in your seat, understand first that this is a sign of good government at work. Any agency responsible for overseeing a sizeable financial program would implement processes designed to protect investors, maintain efficient markets, and facilitate the accumulation and distribution of capital. At some level we want this. 

Everyone also wants to know that they are ‘ok’ in their situation. Anxiety sets in because the rules are at times vague, and, as yet, untested. The smart play is to pursue a rigorous approach of documentation and compliance analytics that enables an elegant and comprehensive response to the IRS should they come knocking.

5. Exiting the program early 

To achieve the greatest financial benefits as an investor in Opportunity Zones, one must hold that investment for a full ten years. The tax advantages increase the longer one is invested, allowing you to defer, reduce, and ultimately eliminate the tax burden. Investors in QOF receive a tax deferral on their initial investment. They can reduce the deferred taxes owed on their initial capital gains by 10% in year five or up to 15% in year seven. Finally, if an investor makes it to year ten, they unlock a phenomenal set of options, including eliminating 100% of the taxes owed from the initial investment. 

Here we are in year five of the program. There are thousands of QOFs that have been operating for between 3 and 5 years in the program. Some of these are surely interested in selling or exiting the program. This will pave the way for the largely untested maneuver of exiting the program and locking in tax breaks based on years of service. Again, the safe approach is to establish and maintain the necessary documentation, self-certifications, and evidence to prove compliance upon exit.


In Sum 

In many ways, the Opportunity Zone program is just getting started. With the potential for updated regulations, the influx of sophisticated investors, and significantly increased regulatory oversight, this space will continue to heat up. In the meantime, the program continues to unlock access to capital for low-income American communities. and sustainably.