A new federal tax shelter seeks to unlock some of the $6.1 trillion in unrealized capital gains and create a downpour of investments in economically parched areas.
And Colorado officials are rushing to cash-in on an economic wave they hope will roll across the plains and mountains.
“The state is in the vanguard,” Bruce Katz, a co-founder of The Governance Project, recently told a Denver audience. “If you are a first mover on policy, you will attract more capital.”
The Tax Cuts and Jobs Act of 2017 created an “Opportunity Zone” program that allows investors to defer and even reduce their capital gains if they invest in economically distressed zones that were set up earlier this year in all 50 states and Puerto Rico.
Colorado was among the first to define 126 census tracts or zones to participate and hosted one of the first state-sponsored conferences on the topic on June 28, complete with experts from around the country.
Katz urged the audience to take the next step and create a State Opportunity Plan, effectively a prospectus that lays out the investment opportunities in the various locations.
“You have to do this,” he urged.
Corporations hold about $2.3 billion in unrealized capital gains and individuals another $3.8 trillion, according to the Economic Innovation Group. Even a sliver of that money invested in struggling communities could transform them.
And that investment could help the Colorado Office of Economic Development and International Trade address one of the toughest issues it has wrestled with — how to shift the prosperity experienced along the northern Front Range to rural parts of the state.
“It is entirely possible for this to be one of the biggest catalysts seen in the U.S. in a long time,” predicted Stephanie Copeland, director of OEDIT, which hosted more than 200 people at its Colorado Opportunity Zone Conference.
Why create another program
Nationally, about one in six Americans live in communities defined as economically distressed, including about 400,000 people in Colorado, said Kenan Fikri, director of research at EIG.
New businesses and jobs have concentrated in a handful of “prosperous” areas, i.e. the northern Front Range, while distressed areas, like southeastern Colorado, continue to shed jobs and suffer a net loss of businesses.
Between 2000 and 2015, Colorado’s most prosperous one-fifth of zip codes added 186,038 jobs and 17,737 business establishments, according to EIG. The rest of the state added only 2,381 jobs and 3,503 businesses.
The bottom two-fifths, the “at-risk” and “distressed” areas lost thousands of jobs and hundreds of business establishments during that 15-year period and have had to watch as their young adults left for better opportunities elsewhere.
“There is no cavalry coming to rescue us,” Jeremy Nowak, author of “The New Localism,” told the Denver audience.
Fikri argues that a lack of investment traps distressed communities in a downward spiral. About 75 percent of venture capital dollars, which drive innovation, are concentrated in just three states: California, Massachusetts and New York.
Large swaths of the country have no access to community development financing and even philanthropic grants, historically used to fill the gaps, are highly lopsided.
In already wealthy New York City, foundations and other philanthropies contribute $2,000 per capita to assist the community, Fikri said. In Alabama, where poverty is more prevalent, contributions run closer to $130 per capita.
EIG’s solution is to use tax policy to drive markets solutions, which took the form of the Opportunity Zone program that Congress approved in December.
How it works
The U.S. Department of Treasury and the Internal Revenue Service are still setting guidelines, but compared to many state and federal programs, the Opportunity Zone is relatively straight-forward.
The language creating zones in the tax bill was six pages, with five of those dedicated to how states should designate zones, something that was done earlier this year, said attorney Marc Schultz, chair of the tax credit finance group with Snell & Wilmer.
Investors have 180 days to invest the capital gains from the sale of an asset or business into an Opportunity Fund, which then must invest up to 90 percent into an equity position in a qualified property or business in a zone.
Creating a fund isn’t hard. An investor can self-certify by completing a form set to come out later this summer and submit it with next year’s tax return. No government agency or bureaucratic approvals are required.
Finding a qualified investment that can provide a solid return will be a little tougher. The goal of the program is to encourage rehabilitation of a building, not just ownership, or investment in a start-up business, not the purchase of a corner store that has been around for 20 years.
At the end of 2026, or sooner if an investor gets out, the capital gains that were deferred come due. But if an investor holds for five years, the tax bill is reduced by 10 percent, and up to 15 percent after 7 years. That creates an incentive to invest earlier rather than later and to hold for the long haul.
The biggest windfall, however, comes to investors who can pour their expertise into an investment and generate high rates of appreciation. Provided an investment is held for 10 years, the new capital gains aren’t taxed.
But the tax breaks allow investors who make more modest returns to benefit. A yield of 6 percent a year in an Opportunity Zone is equivalent to 9 percent in another area, said Steven Mount, an attorney at Squire Patton Boggs.
By 2028, the program expires, although backers hope its success will encourage Congress to approve another round in the near future.
Fikri said renewal is important to avoid creating a fire sale where everybody rushes out the door a decade from now, which will not benefit communities.
Colorado throws a deep pass to rural areas
To qualify as an Opportunity Zone, a census tract had to have 20 percent or more of its population living in poverty, and a median income at 80 percent or below the state median.
Of the tracts that met those criteria, states could designate 25 percent as Opportunity Zones. Colorado decided to give more weight to distressed rural areas over urban ones, which have larger populations and are closer to infrastructure and markets, making them more attractive investment targets.
The state could have placed about 70 percent of its Opportunity Zones in urban areas but decided instead to put 60 percent in rural areas. That requires a tougher sales job of interesting investors in areas that they aren’t familiar with or might consider higher risk.
That rural focus reflects the desire to not add to the strains that growth has created along the northern Front Range and to try and spread opportunities out more widely, a policy priority with Gov. John Hickenlooper.
Over the years, the state has rolled out several programs to boost rural investment, including Enterprise Zones, and then Enhanced Rural Enterprise Zones, and more recently Rural Jumpstart Colorado.
The aim is to team state tax incentives with the new federal tax breaks to make investors consider areas they would have passed over before.
One concern among supporters, however, is that the program will skew too heavily to real estate rather than business startups.
As nice as fixing old buildings in a historic Main Street or finding new uses for an abandoned strip mall might be, the greatest benefits to communities will come in putting workers behind desks, on assembly lines, in laboratories or out in the field.
Chris Montgomery, with Four Point Funding in Steamboat Springs, said Opportunity Zones could convert borderline investments into ones worth pursuing and envisions an all-of-the-above scenario in western Colorado.
An Opportunity Zone Fund could purchase land and build a facility for a new business and provide the startup capital.
But in a game where the clock is already ticking and the referees are still coming up with the rules, investors are scrambling to figure out what play to make.
“It is a good fit for what we have been doing,” acknowledges Scott Reich with the Colorado Impact Fund in Denver. “Everyone is trying to figure out how this is going to work.”This post was originally published here