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Opportunity Zones: A Potential New Source of Affordable Capital for EB-5 Projects

11th Sep 2018

2018 has been a watershed year in the history of the EB-5 program. Despite significant growth in investor subscriptions from emerging countries, China investor subscriptions continue to lag due to lengthening wait times as a result of retrogression. Based on recent legislative and regulatory reports, it is unlikely that there will be any relief through increased buy-in pricing or visa capacity in the near term. The resulting slowdown in funding velocity is causing existing EB-5 projects to consider alternative sources of capital, and new projects to be smaller in size. Both of these approaches adversely affect EB-5 issuers’ businesses.

So, what are they to do? Perhaps surprisingly, the answer may be found in Section 1400Z of the Internal Revenue Code (IRC).

Without much fanfare, the Investing in Opportunity Act (IIOA) was signed into law on December 22, 2017, as part of President Trump’s tax reform initiative. Under this new legislation, taxpayers can defer and reduce taxes on any capital gain by investing in qualified projects within qualified Opportunity Zones (OZs) within 180 days of the sale or exchange that generates the taxable gain.

Upon passage of the IIOA, state governors were given responsibility for identifying low-income areas in their states to be designated as Opportunity Zones. At the end of June 2018, the IRS published a list of 8,700 approved Opportunity Zones which will remain in effect for the next decade.

With over $6 trillion in unrealized capital gains in the market, the Investing in Opportunity Act has the potential to become the largest economic development program in the history of the United States. This is a welcome opportunity for taxpayers, and may be the perfect solution to the current challenges faced by EB-5 issuers such as alternative capital.

In fact, the EB-5 program and the Opportunity Zone tax incentives have many things in common:

First, both programs were designed, at least in part, to stimulate economic development in underserved areas. The concept of an EB-5 Targeted Employment Area (TEA) is analogous to that of an Opportunity Zone. While the definition of an Opportunity Zone, as set forth in the IRC, is closer to that used for the New Markets Tax Credit Program, it remains likely that there is some overlap between OZs and EB-5 TEAs, and therefore some existing EB-5 projects may qualify under the Investing in Opportunity Act.

Second, both programs offer specialized benefits, beyond those of traditional investments, that may result in a lower overall cost of capital for developers. In the EB-5 arena, investors are primarily focused on the immigration benefit, and therefore have historically had lower expectations for their investment’s yield. Similarly, in the Opportunity Zone space, we expect that investors will be primarily focused on deferring and reducing taxes on their gains — and only secondarily on ROI.

Third, in another similarity to EB-5, Opportunity Zone capital is likely to be patient. The IIOA provisions incentivize long-term investment by allowing for a modest step-up in basis for investments held longer than five years: at the five-year mark, the taxpayer’s basis is increased by 10 percent of the original gain, and for investments held at least seven years, the taxpayer’s basis is increased by another 5 percent of the original gain. Furthermore, as an additional incentive to make long-term, patient capital investments, taxpayers holding Opportunity Zone investments for at least 10 years are exempt from taxes on any gains from the appreciation of that investment.

Whereas the EB-5 program is controlled by USCIS, the IRS will oversee the OZ program, and it is expected to issue the first of several sets of regulations later this year to address the numerous unanswered issues raised by the Section 1400Z statute. As we all know, the US tax system is highly complex, so it should come as no surprise that there are program-specific compliance and reporting requirements for both fund managers and individual investors involved in Opportunity Zone investments. For example:

  • Funds must invest at least 90% of their capital in qualified OZ property
  • Funds must track increases to the basis of qualified OZ business property to meet the “substantial improvement” requirement, which mandates a >100% increase in the property’s basis over any 30-month period
  • Funds must document appropriate expenditures and jobs created by the OZ property or business to facilitate economic impact reporting

Failure to meet one of these or many other requirements could be costly, as small errors in administration can easily result in disqualification under the program’s rules — meaning potential back taxes, interest, or fines.

For this reason, we’ve adapted our award-winning eSTAC® financial administration platform into a purpose-built, technology-enabled service for the Opportunity Zone industry. The JTC Opportunity Zone Fund Administration Service combines institutional-quality private equity fund administrative services — including fund accounting, investor services and treasury — with specialized OZ tracking and reporting capabilities at the levels of the fund, investor, and individual investment.

For more than 25 years, we’ve dedicated ourselves to maximizing the security, transparency, and compliance of complex financial transactions in specially regulated markets, such as EB-5 and IRC 1031 tax-deferred exchanges, and we’re pleased to now offer this same level of administrative excellence to the Opportunity Zone industry.

If you’d like more information on how Opportunity Zones can be used as alternative capital for EB-5 or the JTC Opportunity Zone Fund Administration Solution, please feel free to contact us or you can browse our web-based OZ resource center.

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