US Opportunity Zones open the door to foreign investors

When Amazon announced its decision to co-locate its headquarters in northern Virginia and Long Island City in New York, the public was variously amazed and aghast at the approximate $4bn in concessions that the e-commerce giant had extracted from the local governments.

What was not immediately apparent – but quickly became so – was that the site in Long Island City was designated as an Opportunity Zone under a provision of the mammoth US tax reform measure passed about a year ago, the Tax Cuts and Job Act. The benefits that Amazon might accrue because of its new location may well rival the $4bn it is already getting, although admittedly over a long period of time.  

At the time of the law’s passing, the benefits that could be realised under Opportunity Zones were unknown to the business community, partly because of the many other details of the law and partially because no rules or regulations had been put forward to define how the Opportunity Zones would work, or even where they were located.

But as 2018 went on, the Treasury department released more and more information, starting with designating 8700 census tracts in the US as Opportunity Zones. Not all of the rules are in place, and the market is expecting more regulations and definitions from the Treasury in the near future. But enough detail had emerged by the time Amazon announced its plans in November 2018 that businesses and funds were eagerly making plans to invest in these areas. 

How it works

Simply put, Opportunity Zones allow investors to take the profits from the sale of an asset such as a building or business located in one of these 8700 census tracts and defer taxes on those gains until 2026. These tracts are located in 'economically distressed areas', but as is shown by Amazon’s investment, these areas would not necessarily be considered lost causes.

Brien Walton, CEO of Acadia Capital Management II, gives a simple example as to how such an investment would work. “The capital gains rate is 20%, so if an investor owns $1m in company stock, real estate, and so on, that grows in value to $2m,” he says. “Upon sale the taxpayer has $1m in profit, of which they must pay 20% ($200,000) to the Internal Revenue Service [IRS]. With an Opportunity Zone, however, that taxpayer can roll over that $200,000 into an Opportunity Zone Fund and defer paying that $200,000 for 10 years, at which point the tax is no longer owed to the IRS. Even better, if the $200,000 grows to $2m, it is treated the same as the $200,000 because there is no tax due after 10 years.”

Because the rules are still being written, many details are still unclear. But one thing that has been determined is that foreign investors can participate in the programme. “If a foreign investor currently has US-based investments and realises a gain on those investments, they can take advantage of the deferral mechanism provided for investing in an Opportunity Zone,” says Pierre Debbas, a lawyer with Romer Debbas. “If the foreign investor holds the investment for the requisite period of time, north of 10 years, in the Opportunity Zone, then the gains tax on that specific investment would be wiped out.”

Funds forming

Besides the fact that foreign investors can participate, here is what else the market knows about the programme.

To make use of the tax advantages that Opportunity Zones offer, the investor puts its funds into a Qualified Opportunity Fund, which then uses the investments to develop the zone. A Qualified Opportunity Fund must be either a partnership or corporation which elects to be a Qualified Opportunity Fund.

Many funds are forming to target Opportunity Zones around the US, but it is looking likely that individual companies, including foreign ones that meet the criteria (namely that they are US taxpayers), will be able to form their own fund and invest in Opportunity Zones.

“Although the final rules have not been published, foreign companies can form their own fund and invest in Opportunity Zones, though the greatest financial benefit is gained when, for instance, the investor is carrying capital gains from the sale of shares or an asset under a 1031 exchange [a type of tax vehicle that allows the investor to postpone the tax liability] and invest those proceeds into an Opportunity Zone fund or direct investment,” says Robert Barthelmess, managing partner of BGI Capital. Like others, Mr Barthelmess emphasises the greatest benefit of the Opportunity Zones. “The international investor can reduce and even wipe out the tax liability depending on how long the investment is kept,” he says.

Adjacent areas

There is another opportunity available to foreign, indeed all, investors. A better idea might be to invest in deals that are adjacent to Opportunity Zones, says Kevin Mawby, a commercial agent with Melroy Investments. “This way the investor can bypass any cumbersome paperwork or process in qualifying as an Opportunity Fund and reap the benefits of the development surrounding the area,” he says.

One of the key tenets of Opportunity Zone investing is that when an investor forms an Opportunity Fund, they will have to spend a certain amount on improvements within 30 months. These improvements must be equal to the price that was paid for the property, Mr Mawby explains.

“However, if you invest in a property without forming an Opportunity Fund that is either in or adjacent to the zone, you will experience a rising tide that lifts all ships,” he adds. Specifically, given that the rules require Opportunity Funds to make major improvements to the property or business within 30 months of purchase, the surrounding property values will inevitably rise.

This may just be the beginning of this trend. Hong Kong-based Nan Fung Group has partnered with Atalaya Capital Management and Innovo Property Group in the US to redevelop a last-mile distribution facility into a multistorey, state-of-the-art warehouse to address the area’s growing e-commerce market. The building’s location? Long Island City, close to Amazon’s future headquarters and the area’s Opportunity Zone.