House Bills would Expand and Enhance Opportunity Zones, Create Rural Opportunity Zones
Looking ahead to the fall legislative agenda there have been two noteworthy opportunity zones (OZ) bills introduced.
On June 13, the House Ways and Means Committee passed the Small Business Jobs Act (HR 3937), which includes the Rural Opportunity Zone and Investment Act, H.R. 3906, that proposes several provisions to enhance the OZ incentive. The Small Business Jobs Act in addition to the Opportunity Zones Enhancement Act represent a multipronged approach by members of Congress to bolster and expand the OZ incentive.
This recent interest in OZs comes as the industry awaits the reintroduction of the Opportunity Zones Transparency, Extension and Improvement Act (OZTEIA). The OZ incentive, in its sixth year, has been shown to have positive effects on almost 3,800 communities. Total OZ investment reached more than $48 billion by the end of 2020 and the incentive has boosted local home values by 3.4% from 2017 to 2020 with no corresponding increase in rents, according to research by the Economic Innovation Group (EIG). It is estimated the incentive has already created nearly $100 billion of capital investment, with three years left before the incentive expires.
Provisions Benefitting Rural OZs
The Rural Opportunity Zone and Investment Act was initially introduced June 6 by Rep. Drew Ferguson, R-Georgia, and later incorporated into the Small Business Jobs Act (SBA) that was introduced June 9 by Chairman of the House Ways and Means Jason Smith, R-Missouri. The SBA has been championed entirely by Republican members and was passed out of committee June 13.
By creating rural OZs and expanding OZ eligibility, the SBA would significantly increase the number of OZs in the country. For a census tract to be eligible for a rural OZ designation, it must be a rural persistent poverty census tract, which must be in a county in which more than 50% of the census blocks are considered rural and must meet a persistent poverty threshold of 20% or greater over the past 30 years based on data from the Census Bureau. The cost of the provision is estimated to be $1.07 billion between 2023 and 2032. The act also overhauls the low-income community definition used to determine OZ eligibility, separating it from the one used to determine new markets tax credit eligibility, specifically excluding median income from consideration.
The new proposal would designate 1,926 rural census tracts as rural OZs. These zones would be concentrated in the Southeast and Midwest, with 684 existing OZs being redesignated and 1,242 census tracts newly designated. All but four states (Delaware, New Hampshire, Rhode Island and Nevada) and Washington, D.C., would have at least one rural OZ based on the eligibility requirements detailed above. EIG research shows that the bulk of the newly eligible census tracts would be in Appalachia and the South. As detailed in the graphic below, if the bill is enacted, many states would see dramatic increases in overall OZs—Mississippi and Kentucky would see more than 100 new census tracts added to their total OZs count. Only eight states would see less than a 5% increase in OZs, and another six states and Washington, D.C., would see no increase at all.
The bill also removes some of state governors’ powers over OZ designation, a shift from the leading role they had previously played in the designation process. While the original OZ incentive allowed the leading state official to designate at least 25% of eligible low-income census tracts as OZs, the new proposal would designate all census tracts meeting the rural persistent poverty requirements as ROZs. The new proposal not only removes governors from the selection process, also bases eligibility on poverty rates, rather than incomes.
As noted below, the bill includes most of the extensive reporting provisions found in the bipartisan OZTEIA of 2022. The act would allow for deferral of capital gains invested into rural qualified opportunity funds (QOFs) until Dec. 31, 2032. The rural OZ mimics the benefits provided for in the current OZ incentive, with a five-year hold basis step up of 10%, a seven-year hold basis step up of an additional 5% and after a 10-year hold, taxpayers could make an election whereby the basis of their investment would be equal to the fair market value of such investment on the date that the investment was sold or exchanged.
If enacted, rural QOFs would be required to hold 90% of assets in qualified rural OZ property (tested twice annually). Qualified rural OZ stock/partnership interests would need to be acquired after Dec. 31, 2023, and the entity would be required to be organized as a qualified rural OZ business at issuance or in the process of being organized and be a qualified rural OZ business for substantially all of the rural QOF’s holding period. Qualified rural OZ property would be defined as tangible property used in a business if it was acquired after Dec. 31, 2023, had been substantially improved over a 30-month period and if all of its substantial use during a 30-month period was in a qualified rural OZ. Tangible property that ceases to be qualified rural OZ business could continue to be treated as qualified rural OZ business for five years. Qualified rural OZ businesses would be defined as having substantially all its property being used in a qualified rural OZ business and not being a sin business. Expanding the OZ incentive to additional areas, like rural census tracts, would increase the reach of the incentive, helping those communities most in need receive investments.
Originally, the Investing in Opportunities Act (IOA) included extensive reporting requirements for the OZ incentive. Because of Senate budget reconciliation rules, reporting requirements were removed from the final bill language included in the Tax Cuts and Jobs Act (TCJA). Proposed OZ legislation since has included reporting, including the Small Business Jobs Act. QOF and rural QOF reporting is identical to the reporting requirements found in the proposed OZTEIA, which drew from the IOA. Requirements include the provision of:
- Name, address, Employee Identification Number (EIN), organized as a corporation/partnership; and,
- Value of total assets/qualified rural OZ property.
With respect to investments held, the following is required:
- Name, address, EIN; North American Industry Classification System (NAICS) Code(s) of each qualified rural OZ business;
- Census tract number(s);
- Values of investment, and tangible property owned/leased by qualified rural OZ business;
- Approximate number of residential units; and
- Approximate average monthly number of full-time equivalent employees.
Unlike the OZTEIA, which required investors to provide additional information on their OZs investments, there are no reporting requirements for investors in the new bill.
QOF penalties for failing to meet reporting requirements would be $500 a day up to a $10,000 fine (which can go up to $50,000 for large QOFs). In turn, penalties could go up to $2,500 a day for intentional disregard up to a $50,000 fine (with a $250,000 possible fine for large QOFs). There would be no reporting penalties for QOF investors. Proposed congressional reporting rules require annual, publicly available reports to Congress, as well as semi decennial reports.
The inclusion of reporting requirements, and penalties for failing to provide the required information, address the bipartisan call for more information about the incentive. With billions invested so far–Novogradac’s survey of QOFs (capturing a multi-investor subset of the total market) finds that more than $36.1 billion in equity investments has been raised as June 30, 2023–having information about the type of investments made will help further analysis of the incentive and whether it is meeting its intended goal of bringing investments and opportunities to underserved communities.
Legislators Look to Enhance the OZ Incentive
On April 25, Sen. Tim Scott, R-South Carolina, Ranking Member of the Senate Committee on Banking, Housing and Urban Affairs, released a discussion draft of his proposed Renewing Opportunity in the American Dream (ROAD) to Housing Act. Scott, an integral figure in the enactment of the initial OZ incentive as a part of the TCJA, made sure to include OZs in this housing-focused bill. Chiefly, the legislation would make, “targeted reforms across all segments of the U.S. housing market,” including improving financial literacy, increasing access to housing, targeting vulnerable populations, promoting good governance and promoting opportunity. Under promoting opportunity, the bill requires the Secretary of the Department of Housing and Urban Development (HUD) to prioritize awarding of all HUD grants to recipients located in or primarily serve communities designated as OZs.
In addition, on June 20, Rep. Andy Barr, R-Kentucky, introduced the Opportunity Zones Enhancement Act of 2023 in the House with similar aims. The act would further incentivize taxpaying banks to increase their lending in OZs and would lower borrowing costs for OZ businesses, helping banks to fulfill their Community Reinvestment Act requirements. These changes would serve to attract capital to stimulate further growth in OZs through increased investment. Rep. John James, R-Michigan, also proposed the Reignite Hope Act on July 10, which could create a tax credit for certain employees of critical industries located in OZs. Critical employees would include healthcare professionals, law enforcement officers, first responders and caretakers. Qualifying individuals would have to work full time for at least 75% of the taxable year in a job located in an OZ.
While the Small Business Jobs Act does appear to be championed only by House Republicans so far, it represents a significant step forward and a push to expand the OZ incentive and to grant OZ eligibility to large rural swaths of the country. Still, there are questions about the legislation as written that need to be addressed, particularly, how newly designated rural OZs would work within the existing OZ incentive framework, e.g., rectifying the different investment timelines. OZs have been a key element in invigorating investments in distressed communities across the country, increasing property values and boosting the housing supply, as evidenced by Novogradac’s Qualified Opportunity Funds survey.
As of this writing, the economic development tax package, of which the Small Business Jobs Act and Rural Opportunity Zone and Investment Act are a part, has created conflict because some House Republicans (primarily from New York, New Jersey and California) want to add a reform of state and local tax deduction cap and House Democrats oppose the main revenue-generating offset proposal (or “pay-for” proposal) that would repeal Inflation Reduction Act (IRA) clean energy tax incentives. It should be noted that the key elements of the tax package, including the OZ proposals that do not require using the IRA clean energy tax incentives as a revenue-generating offset proposal, remain in play for a year-end tax bill. As Congress left for summer recess before the bill could be considered in the House—the House is scheduled to return Sept. 12—the status of the bill remains unclear at the time of this writing. Still, any OZ-related bills would need a tax legislative vehicle. At present, the possibility of “minibus” spending bills, bills that contain smaller combinations of the 12 annual sending bills that must be passed for the 2024 fiscal year, present potential vehicles in which year-end tax legislation such as OZs proposals could be included. The overhaul of OZ eligibility, as well as the changes to QOF law represent a significant commitment to the OZ incentive in general as well as its effects on distressed and disadvantaged areas across the country.
To stay abreast of OZs news, such as action around the this legislation, and have a voice in the future of the incentive, including possible extension past the current 2026 deadline, consider joining the Opportunity Zones Working Group. Membership details can be obtained by submitting this online form. Those interested in gaining insight on the incentive, the possibility of enacting the rural OZ incentive and hearing from industry leaders should also plan to join us at the upcoming Novogradac 2023 Fall OZ Summit taking place Nov. 1, in Washington, D.C.