BEYOND THE NUMBERS
Companion bills from Senate Finance Committee Ranking Member Ron Wyden and House Majority Whip James Clyburn would impose significant, and welcome, new guardrails on investments in “opportunity zones,” or low-income areas designated for special tax breaks.
Created by the 2017 tax law, the opportunity zone (OZ) provision lets investors defer taxes on capital gains (profits from the sale of appreciated assets, such as stock) by “rolling” those gains into funds that invest either in property in opportunity zones or in businesses operating at least partially in opportunity zones. If investors keep that money in these funds for a certain number of years, they can get more tax breaks — including lower taxes on their deferred capital gains and a permanent tax exemption on all capital gains on their OZ investments. That’s on top of the generous tax advantages that capital gains already enjoy, including a preferential rate and the ability to defer taxes until appreciated assets are sold.
The direct tax benefits of opportunity zones will flow to wealthy investors and, as we and others have warned, there’s no guarantee their investments will ultimately help distressed communities. We have recommended that the Treasury Department issue regulations to prevent this tax preference from becoming the source of new tax shelters that generate large tax breaks with little or no actual benefit for opportunity-zone residents. Recent reporting from the New York Times and ProPublica further highlighted major flaws with the OZ tax break and its administration to date.
The Wyden and Clyburn bills would limit some potential abuses of opportunity zones, many of which we identified in our comments on Treasury’s proposed regulations, by:
- Adding guardrails. The bills would plug many of the holes in Treasury’s proposed regulations that make it easier for investors to claim tax benefits even if they make only minimal new investments in the zones. For instance, the bills would require OZ funds that buy undeveloped land to invest new capital to improve the land in order to claim tax breaks. They would also require OZ businesses to locate at least 90 percent of their physical assets in opportunity zones, instead of 70 percent as under Treasury’s proposed rules.
- Restricting investments unlikely to help low-income residents. The bills would limit investors’ ability to claim tax breaks for investments such as luxury apartment buildings, self-storage facilities, and sports stadiums, which wouldn’t likely create significant benefits for low-income residents. Luxury real estate reportedly has been the biggest beneficiary of the OZ provision so far, which raises concerns that the tax break could accelerate gentrification and the dislocation of current residents.
- Disallowing relatively affluent areas. The bills would exclude relatively high-income areas from being designated as opportunity zones. The law’s original text permitted areas that aren’t truly distressed to qualify, such as booming areas of New York City and Los Angeles. Areas like these may represent a small share of opportunity zones but could attract a large share of OZ investment and account for a disproportionate amount of the lost federal revenue.
The Wyden bill would also require OZ funds to collect information about their investments and their investors and provide the data to the IRS and the public. This would help policymakers and outside analysts evaluate how the incentive is working and whom it benefits. The bill would impose penalties on OZ funds that provide false information.
Opportunity zone advocates might argue that the bills’ guardrails would reduce investment in opportunity zones. But if the tax break is truly intended to improve the lives and opportunities of low-income residents of the zones, it should target investments that focus on that goal.
While the Wyden and Clyburn bills would make important positive changes, they may not be sufficient by themselves to curb abuse of the OZ tax break. Congress should continue exercising its oversight authority to evaluate the program and determine whether further revisions are needed, such as a requirement that OZ investments create jobs for low-income residents or otherwise directly benefit low-income households in OZs.
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