Mike O'Donnell | Jan. 22, 2019

Opportunity Zones & Small Biz

Opportunity Zones were created as part of the federal tax reform package enacted in late 2017 with the intent of addressing some of the uneven economic recovery that has occurred since the great recession, which left many low-to-moderate income census tract areas (LMI census tract areas) lagging behind their more affluent neighbors.

The legislation required each state governor to identify 25% of the LMI census tracts in their state as Opportunity Zones and thus potentially eligible to receive investments from Qualified Opportunity Funds.

Opportunity Funds are self-designated investment vehicles that can deploy capital that would normally otherwise be subject to capital gains taxes, into Opportunity Zones by either investing in brand new businesses OR by investing in real estate projects where a “substantial improvement” will incur within 30 months of purchasing the real estate.

The individuals or organizations making these investments earn a temporary deferral of any capital tax payments they would otherwise have to make until funds are withdrawn.  Additionally, the investors can earn a permanent holiday of up to 15% on the tax they might owe if they keep their money in the Opportunity Fund for at least ten years.

It is thought that the 8,761 Opportunity Zones now designated nationwide, including 126 in Colorado, could potentially attract trillions of dollars in new investments and the thinking from the policy folk wearing the dark suits in DC, is that all of this extra investment will help create both wealth and jobs in areas of the economy where both are sorely needed.

In Colorado, it is hoped that Opportunity Zones will specifically address a number of challenges the state faces by:

  • Promoting economic vitality in parts of the state that have not shared in the general prosperity over the past few years
  • Funding the development of workforce and affordable housing in areas with escalating prices and inventory shortages
  • Funding new infrastructure to support population and economic growth
  • Investing in startup businesses that have the potential for rapid increases in scale and the ability to “export” outside the state of Colorado
  • Upgrading the capability of existing underutilized assets through capital improvement investments

The map of Opportunity Zones for Colorado can be found at here, where you can type in an address to see if a location is qualified. This 50,000-foot view of Colorado shows the clustering of Opportunity Zones within the state (yellow-shaded areas) and unlike other regions of the county, where most of the Opportunity Zones were designated in metro communities, Colorado has done a great job ensuring that rural communities are very well represented under this program.

And unlike previous place-based federal or state policy initiatives, the Opportunity Zone program comes with very few conditions, so investors and investments don’t need to be vetted or approved like they do under, for example, the New Markets Tax Credit program. There are some restrictions in the legislation, so golf courses and massage parlors are off the table, and some ambiguity still exists around specific operational guidelines, which the IRS is likely to address in the very near future, but otherwise this program will be one that will be very easy to use/access.

Unfortunately, though, from an economic perspective, the true impact of the Opportunity Zone program will be hard to measure. Some newly designated Opportunity Zone areas are areas that are already being developed and would have continued to be developed without the program so there is no validity in attributing the creation of the program as helping development in those areas. (The case in point for Colorado being those designated Opportunity Zone census tracts straddling E-470 south of DIA and north of I-70 – development is already occurring there and would continue to occur there with or without the Opportunity Zone designations.)

And when looking at other areas of the state, the challenge associated with stimulating any sort of significant Opportunity Zone development in a community like Cheyenne County in far east central Colorado, where there is a total population base of just 1,845, may be insurmountable.

The fact that the program is partly intended to funnel new capital into startup businesses, is also misplaced. It is a shame that politicians and their advisors don’t understand that tax credit type programs rarely, if ever, help a startup or early stage small business even though there is no better way of improving a community and reducing poverty than by helping individuals start and grow their own small businesses.

But because the government doesn’t have to “spend” any money if they are giving someone a credit to help them start a business, these sorts of go-to policies are easy to implement because it appears as if the government is actually doing something impactful even though they aren’t.

Let me go out on a limb and suggest that 99.9% of all the Opportunity Fund investments that will be made in Colorado through the end of 2019 will go into real estate projects. Almost nothing will go to directly help small business creation and this is both a real shame and yet another example of how well-intentioned legislation again misses the mark. We will certainly see a lot of new real estate developments in the state over the next few years, which will be great for everyone in the construction industry, but do we really need a plethora of a new absentee landlords setting up shop in Colorado?

The Opportunity Zone legislation will likely result in an acceleration of gentrification in certain areas of Denver and other Front Range communities. There will be “new” investments in areas where the investments would have occurred anyway. There will certainly be, and we are already seeing, some very impactful investments in certain western slope communities where there is a critical population mass and well-organized support for needed economic growth. But speaking as a resident of the eastern plains, I can’t imagine investors salivating about potential projects out that way. (At least not since the state sanctioned the draining of Bonny Dam.)

The Opportunity Zone program is definitely the bright shiny object du jour currently attracting the attention of investors all over the nation who want to defer and partially reduce capital gains tax obligations. The Joint Committee on Taxation has estimated that it will cost the federal government $1.6 billion in forgone tax revenues over the next ten-years but the sad reality, from an economic perspective, is that it will be hard to work out, at the very end of the day, whether the program has been successful or a complete waste of taxpayer funds.

It certainly won’t help accelerate the rate of growth of startup small businesses in Colorado’s low to moderate and, particularly, rural census tracts and if doesn’t do that, it isn’t a very good program at all from where I am sitting on the other side of my barbed wire fence.