A recently-introduced bill would add new Rural Opportunity Zones and institute long-desired reporting requirements. Here’s what that means for the future of the program.
After a long wait, there is finally news out of Congress regarding Opportunity Zones. OZ stakeholders have long wanted Congress to update the program by recalculating OZ tracts and instituting impact reporting requirements that would help remove bad actors and demonstrate the good some OZ projects are doing for underserved communities.
In the years since the initiative was created as part of the Tax Cuts and Jobs Act of 2017, OZs have attracted billions of dollars of investment. But with no reporting requirements, the public has often been given a negative impression of the program, harming its chances of being extended.
These new initiatives are part of a larger package of legislation recently passed by the House Ways and Means Committee that includes many updates to the tax code. The likelihood of the bill’s passage may depend on these other components of the bill, which could hurt its chances if they prove unpopular.
Even if the proposed legislation is not ultimately successful, the chance to debate (and hopefully pass) improved OZ language should be welcomed by the industry.
Can this bill give OZ what it sorely needs and improve the program’s chances of renewal? Let’s examine what’s in the bill, what isn’t, and what it means for Opportunity Zones.
How the new bill would change Opportunity Zones
The Small Business Jobs Act (H.R. 3937) contains several revisions to the tax code, including an increased threshold for Form 1099 reporting and changes to exclusions on gains from small business stocks. But there are two sections that deal with Opportunity Zones: one that focuses on a new set of rural OZ tracts and another related to reporting requirements.
Sec. 6. Establishment of special rules for capital gains invested in rural opportunity zones.
This section would create new Opportunity Zone tracts in rural areas, using different criteria from the original initiative in order to select them. While the rules for Opportunity Funds and OZ investors seeking tax incentives would be largely the same as with current OZ investments, how these new OZs are defined is worth taking a look at.
From the bill:
The term ‘qualified rural opportunity zone’ means any population census tract which—
(i) is located in a rural county, and
(ii) is in persistent poverty (as determined by the Bureau of the Census using the same methodology and data as used for purposes of the May 2023 report of such Bureau entitled ‘Persistent Poverty in Counties and Census Tracts’).
As explained in an analysis of the bill by Economic Innovation Group, in order to qualify, a census tract would need “to a) be in a county in which at least 50 percent of census blocks are considered rural and b) meet a persistent poverty threshold of 20 percent or greater poverty rate over the past 30 years based on a recent Census Bureau analysis.”
According to EIG, there are “1,926 rural census tracts that meet the definition outlined in the legislation.” These new OZ tracts will be treated largely as a separate program running in parallel to the current OZ initiative. The timeline would be different, with a program end date of December 31st, 2032.
Sec. 7. Reporting on qualified opportunity funds and qualified rural opportunity funds.
This section deals with reporting requirements for both existing Opportunity Zones and the new Rural Opportunity Zones, which will be subject to the same reporting requirements as current OZs. The bill details expanded requirements for Qualified Opportunity Funds and the information they will now have to provide as part of annual reports. Most of these requirements deal with financial information related to each fund and its investors, but of note is a requirement to report on job creation. Specifically, the bill requires funds to disclose:
The approximate average monthly number of full-time equivalent employees of such corporation or partnership for the year (within numerical ranges identified by the Secretary) or such other indication of the employment impact of such corporation or partnership as determined appropriate by the Secretary.
The term “Full-time equivalent employees” may be misleading – the bill notes that this refers to any full-time employees with respect to any month, but also includes a calculation based on the hours of part-time employees “by dividing the aggregate number of hours of service of employees who are not full-time employees for the month by 120.”
Penalties for non-compliance
The bill outlines penalties for Qualified Opportunity Funds (and Qualified Rural Opportunity Funds) that do not disclose the required information, including fines of “$500 for each day during which such failure continues” up to a maximum of $10,000. For funds with gross assets in excess of $10 million, this maximum increases to $50,000.
There are different rules if the failure to report is considered to be due to “intentional disregard,” with daily fines of $2,500 and a total maximum of $50,000 ($250,000 for funds with assets in excess of $10 million).
Public report on OZ data
The bill includes a provision that the Secretary of the Treasury must issue an annual report that is to be made publicly available. Among the information required for this report is:
- The number of Qualified Opportunity Funds
- The aggregate dollar amount of assets held in QOFs
- The percentage of census tracts designated as QOZs that have received QOF investment
- For each OZ tract, the approximate average monthly number of full-time equivalent employees of QOZ businesses for the preceding 12-month period
- Other elements like the percentage of investments by QOFs that are real property and the aggregate dollar amount of investments made by QOFs in each census tract
In the 6th and 11th years after the bill’s enactment, other information would be required to update the public on “the impacts and outcomes of a designation of a population census tract as a qualified opportunity zone as measured by economic indicators, such as job creation, poverty reduction, new business starts, and other metrics as determined by the Secretary.”
For each census tract designated as a Qualified Opportunity Zone, reporting for this 5-year period should include a comparison between OZ census tracts and similarly-populated census tracts not designated as Opportunity Zones, providing an easy way for the public to understand the effect OZ is having on communities.
Factors that will be considered include unemployment rate, number of persons working in the census tract (including the percentage who were not residents in the tract the previous year), median family income of residents, property values, affordable housing units, and individual, family, and household poverty rates, along with several other potential indicators.
Not only would this bill create a whole new set of Opportunity Zones, it would increase the reporting burden on Opportunity Funds and the Treasury Department in order to provide greater transparency regarding where OZ investment is going and the effect it is having. So what should current OZ fund managers and investors think of this bill? Will it accomplish what we’ve long hoped?
Analysis of the bill – is this good for OZ?
The effects of these four major changes are varied, so it’s helpful to take a look at them one-by-one:
Rural Opportunity Zones
As noted by EIG, the requirements for Rural OZ designation will create a number of new census tracts receiving OZ benefits, but they aren’t a perfect fit. While many of these areas are among the most high-poverty in the country, EIG found that “of those qualifying tracts, more than one-third (684) are already designated in OZ communities.”
The creation of new Opportunity Zones should be seen as a good thing, and this would greatly alter the OZ map in terms of which states are being targeted the most. But there was not a lack of rural tracts available in the original OZ map – rural counties were represented proportionally to their share of overall counties in the U.S. The problem, as many communities discovered, was that it was difficult to find rural investment projects that could attract investors. These new zones may suffer the same difficulties.
Because the timeline for these rural investments is different from current Opportunity Zones, there would potentially be a period where Rural Opportunity Zones are able to accept OZ investment while current Opportunity Zones would not. The thought may be that Rural OZs are to be a replacement for the present program.
This would not only be disappointing for urban areas that benefit greatly from OZ investment, but there is insufficient evidence to suggest that once urban OZs are no longer an option, investors would automatically make the switch and invest more in Rural OZs. A much better solution would be to extend the current program so that the timelines match, giving Opportunity Funds more time to demonstrate to investors and the general public how effective these projects can be with the help of the new reporting requirements.
Some rules are still unclear, including “rules to prevent abuse” that are not defined. Ideally, these vague areas would be cleared up before final legislation is votedon, as rules to prevent fraud and abuse are exactly what the industry has been clamoring for.
With so many specifics left up to the Secretary’s discretion, actual implementation of the law could take a long time. When OZ was initially created, the rollout and clarification of rules took so long that the initiative got off to a slow start. We don’t want that happening again, which is why more specifics in the bill would be good for the industry.
Reporting on job creation
There are positives and negatives to the inclusion of job creation metrics. As noted, many in the industry have long been proponents of impact reporting in order to weed out bad actors and shine a light on those who are making a real impact. This type of reporting could help investors choose the Opportunity Funds doing the most good for underserved communities.
On the other hand, job creation is just one type of impact. Currently, OZ projects don’t have to measure any impact, and if job creation were the sole mission of the program (as in EB-5, which uses the number of jobs created as its impact indicator), this would suffice.
However, not all projects are designed solely to create jobs. As we saw in JTC’s 2023 impact investing survey report, OZ investors have an array of passions, and every project has different impact goals. If the goal of a project is to promote sustainable farming practices, expand internet access, or build affordable housing, job creation might not be the best way to measure its results. If the wrong metrics are used to evaluate a project’s impact, the fund (and the program as a whole) could appear to be accomplishing less than it actually is.
We’d like to see Congress settle on a sensible standard that takes into account the many types of social impact these projects can have. This could be done by employing a single metric such as Impact Rate of Return on top of job creation statistics, or it could involve incorporating a number of methodologies.
This type of expanded impact reporting could potentially help investors identify the funds that are having the greatest impact (helping them stand out in a crowded marketplace) and those that are bad actors. If not, Opportunity Zones will go from being a community investment initiative to a job-creation initiative. Job creation is a good thing, but OZ is capable of so much more.
Penalties for non-compliance
The suggested penalties are necessary in order to ensure compliance from Opportunity Funds, though the method and amounts of the fines could be up for debate. These penalties are stiffer for larger funds to ensure they institute the proper controls rather than taking a small fine to avoid the hassle of complying. With larger penalties for larger funds, ideally everyone will have incentive to follow the rules.
The “intentional disregard” section means funds will want to have all documentation in place to prove that any mistakes or delays were unintentional. This notion of intentionality isn’t spelled out in detail and could be interpreted in a number of ways. Would it be considered “intentional disregard” if the fund doesn’t have third-party impact tracking? Opportunity Fund managers will want clarity on this as soon as possible.
Public report on OZ data
This section is the most important for the future of the program as a whole. Finally, the public will get information not only on the amount of investment being made in OZ tracts, but about the impact OZ projects are having. As stated above, diverse impact information that goes beyond job creation would be useful, and the bill does provide a number of metrics the Secretary can employ.
The addition of a comparative analysis every five years will help stakeholders compare the areas where OZ investment has been made with those that haven’t received OZ designation. This could potentially improve perceptions of OZ among the general public and help regulators (and industry stakeholders) understand why some projects and tracts have been more successful than others, information that will be useful in tweaking the program in the future. The bill could contain more in terms of fund and program-level impact reporting, but this is a great start.
Unfortunately, there are things the bill doesn’t have, like a redrawn OZ map. It also doesn’t include an extension of the timeline for non-rural Opportunity Zones, meaning the initiative still faces the possibility of expiration if other legislation is not passed.
Another issue is clarity: as mentioned, vagueness in the law can mean periods of uncertainty as we wait for finalized regulations. The more specific the bill text can be made during Congressional debate, the faster these changes can be implemented.
Overall, the bill may be missing a few things and wouldn’t give us the long-term program extension we’ve hoped for, but it could be a big leap forward for the OZ sector and those who want to see the initiative live up to its full potential.
How should you prepare for this new legislation?
The bill still has to be debated in Congress, and as we’ve seen with previous OZ bills, it could get stalled and fail to pass. The fact that many other tax-related proposals are part of the same bill could be helpful or could be a hindrance – we’ll just have to wait and see.
In the meantime, fund managers should understand that if these new rules are implemented, they will apply to all Opportunity Funds, not just new funds or projects. That means you’ll need to quickly adapt after any new legislation is passed. JTC is on top of these issues and ready to help our clients institute the correct policies and procedures to fully comply with any changes in OZ rules.
One way we’re able to stay ahead of the curve is that JTC already offers many solutions that would be required by this new law. As a leader in OZ fund administration, we’ve pioneered methods for social impact reporting and provide automated document creation through our 24/7 online portal, ensuring fund managers can provide regulators and investors with the transparent reports they need – not once it’s required, but right now, while it’s still a major differentiator for Opportunity Funds.
Our clients can be confident that JTC is ready to adapt our solutions to comply with any new legislation. Regardless of whether this bill passes or any future rule changes are instituted, we can help Opportunity Fund managers implement the administrative functions they’ll need not only to comply with regulations, but to stand out in the marketplace. If the things we’ve already been doing are now being considered for adoption industry-wide, we must be doing something right.