Opportunity Zone: An Opportunity For Unaccredited Investors

The Tax Cuts and Jobs Act of 2017 established a new federal tax incentive for  investing into a “Opportunity Zone” intending to spur investment in low-income communities. With the passage of the tax overhaul, and the sections relating to opportunity zones, there has been a rush of private equity funds, real estate developers and investors, banks and other accredited and qualified investors, rightly trying to understand the potentially massive tax saving implications of the legislation.

On July 31, the Maryland Department of Housing and Community Development convened the ‘Maryland Opportunity Zone Conference’ at the University of Maryland College Park. Supporters of the Opportunity Zone incentive seized this opportunity to tout their ability to get capital “off the sidelines” (or otherwise out of the unrealized gain line item of the wealthy’s balance sheet), and instead invested in otherwise underserved and underdeveloped neighborhoods.

The Opportunity Zone Legislation

By providing a clear tax savings opportunity for accredited investors, not only by allowing capital gains taxes to be deferred upon their reinvestment in an opportunity fund to be invested in these opportunity zones, but also by allowing gains earned from these investments to grow potentially tax free (subject to certain requirements regarding the length of such investment).

While the legislation is of clear potential benefit to the wealthy and to accredited investors, due to its focus on investment in often underserved communities, it also may serve to provide a unique opportunity for smaller unaccredited investors, who are often not included in fund raising efforts due to limitations imposed by securities laws.

The securities laws define an ‘accredited investor’ as a person who has a net worth of $1 million excluding their primary residence, or who has earned income of greater than $200,000 ($300,000 for married couples) for the preceding two years, and has an expectation that this will hold true in the future. Existing securities laws limit (i) the amount of money that may be raised in a private offering, and (ii) the number of unaccredited investors that are permitted to participate in a private offering. The disclosure requirements for offerings to accredited investors are more relaxed, and as a result, large institutions or funds engaging in private offerings often limit their efforts to accredited investors.

The assumption inherent in these restrictions is that a person that meets these criteria has the financial wherewithal and can bear the risk of a loss of their investment. While the purpose of these restrictions is to protect individuals from being taken advantage of, they can also act as a barrier for individuals who may not meet the necessary financial thresholds, but who nonetheless have the financial wherewithal and understand and are willing to take on such investments and the inherent risks.

Indeed, the accredited investor rules also have had the consequence of ensuring weighted economic benefits for the wealthy through their ability to pool funds for investments. Thus, there remains the looming fear that the Opportunity Zones incentives will end up providing a new vehicle through which these disinvested neighborhoods will be gentrified. While possible, the challenge to these neighborhood investors, the developers who are on the ground doing the work that may not get the notice of the larger developers, is to recognize the opportunities presented through the opportunity zone incentives. For those paying attention, the Opportunity Zone incentive provides the smaller developer, who is more likely to be actively involved in the neighborhood, the opportunity to reap some of the benefits that have often been reserved for wealthy, accredited, and/or institutional investors.

The ability to pool resources by taking capital gains earned from the sale of property or other assets and, rather than those gains being subject to immediate tax (possibly at the ordinary income tax rate based on the length of the holdings), invest those capital gains in an opportunity fund, not only allows for the deferment of taxes but also the potential of gains from such investment growing tax free if left in those investments for the required 10 year period. While larger investors will certainly reap the benefits of the legislation, smaller developers nonetheless have the opportunity to capitalize on the legislation while playing a role in the development of their neighborhoods.

–Original Source JDSupra.com –