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Capital gains break encourages private community investment

Ron Brochu, BusinessNorth
8.12.2018

BusinessNorth reports on Opportunity Zones: Creating Conditions for Success in Duluth & the Northland forum that was sponsored by the City of Duluth and Duluth LISC. 

The excerpt below is from:
Capital Gains Break encourages Private Community Investment

By Ron Brochu, BusinessNorth

 

Program identifies ‘opportunity zones’ with goal to relieve uneven development

Duluth and several rural spots in the region are eligible to participate in a new federal program designed to encourage private investment in low-income census tracks.

A provision in the 2017 Tax Cut and Jobs Act created the “Opportunity Zone” tax incentives program. Its provisions were outlined to about 70 potential investors and area economic developers last month at a forum sponsored by the Local Initiatives Support Corp. (LISC).

“We’re hoping this will spur new economic development and new partnerships,” said Duluth LISC Executive Director Pam Kramer. “It’s new to everybody. We all are learning together.”

In part, the program was created because new business formation is near a record low. Distressed communities experienced a 6 percent decline in local businesses during the economic recovery that followed the Great Recession.

Additionally, Kramer said, more than $6 trillion in unrealized capital gains are pagebeing held by investors. The program represents an opportunity to roll those gains into community development. It’s the first new community development program to emerge in nearly 20 years.

Basically, it’s a prime opportunity for those who have sold an investment and are looking for a new one. Participants, whether corporate or individual, will benefit through a reduction in the capital gains they earned upon selling a current investment to join the Opportunity Zone (OZ) program. The fund transfer, however, must occur within 180 days. Then, if they keep their money invested in the OZ program for specific time periods (see sidebar), they will reduce future capital gains taxes on that new investment. But there’s a need to get on board soon. The tax benefit is the highest if investments remain in place for longer periods, and the clock is already ticking on the 10-year program.

“It’s structured to get investment very soon,” said Kevin Boes, president and CEO of the New Markets Support Company, a seven-year-old division of LISC. Those who wait the until the end of 2019 will already miss one deadline, Boes said at the July 10 forum, where he was a presenter.

The reduction only applies to federal capital gains taxes, which are set at 24 percent. At the current time, Minnesota has no provision in place to reduce state capital gains taxes through the OZ program."

Goals and requirements

Research has found that the post-recession recovery has been uneven, with most investment occurring in strong growth areas while poor areas are being overlooked. Those disadvantaged areas (as defined by Census poverty data) have been identified in all 50 states. Minnesota has 128 zones including ones in Duluth and Lake, Cook and St. Louis counties. In Wisconsin, nearby zones can be found in Douglas, Ashland, Washburn and Sawyer counties.

Opportunity Funds can be organized as corporations or partnerships, local promoters said in a summation of the forum. Within six months of being established, 90 percent of their capital must be invested as equity (not debt) into OZ property. Various investments qualify including:

• New equipment and other assets.

• Business investments, such as in new stock issued for corporations and ownership interests in partnerships and LLCs. Venture capital funds and operating business private equity are eligible.

• Investments in real estate are eligible but must include an ownership interest in new construction or assets that will be substantially improved within 30 months of acquisition by the Opportunity Fund. Those who engage in rehabilitation must make a substantial equity investment and at least double the basis of the assets, Boes said.

“They don’t want you to buy an asset and just sit on it,” he noted.

The investments can be used in conjunction with some other incentives such as those dedicated toward affordable housing.

Pros and cons

Panel members at the Duluth forum cited a variety of strengths and weaknesses associated with the OZ program.

Zones are designated by states and localities, not the federal government.

That creates more local support, Boes said. Further, Opportunity Zones are an unlimited resource having no financial ceiling, he added, that will attract high net-worth investors from other regions to local communities to make investments.

“This is a big source of capital for communities. If we do it right, it can be a groundbreaking program and will be a great tool for cities,” said Amy McCulloch, deputy director for Twin Cities LISC.

On the other hand, there’s not yet a lot of clarity surrounding the rules, which could make it difficult to ensure potential investors will feel comfortable, noted Keith Hamre, city of Duluth planning director.

“Regionally, it’s a challenge to know where all the funds are and align them with areas of need,” he added. But if there’s a lack of oversight, it could lead to program abuses, Hamre noted.

Investments also might lead to gentrification and the displacement of existing residents and businesses. “The idea of outside investors coming in and possibly creating luxury housing would be problematic,” McColloch said.

Further, lawmakers might use the new incentives as an excuse to diminish or end other community development tax incentives.

Developing plans

Linking funders to the appropriate Opportunity Zones could be a challenge in rural areas that haven’t recently updated their development plans. They can benefit by setting priorities, said Karl Schuettler, director of marketing, research and analysis for the Northspan Group, which is helping applicants complete their paperwork and have the appropriate tools in place.

Duluth is in a different situation, having recently completed the “Imagine Duluth 2035” comprehensive plan, said Duluth Economic Development Authority Director Heather Rand. With that in hand, city officials defined the OZ as a narrow area from Central Avenue to about 11th Avenue East. It includes Garfield Avenue and Canal Park. Development priorities are based on the comprehensive use plan, which prescribes priority areas. Funds could be used for projects including the Armory, medical zone housing or ones in the HART district, Rand said.

“A priority for the mayor is Lake Avenue at First Street, Pastoret Terrace, perhaps adding housing in Canal Park, projects along Railroad Street, ones sought by the Port Authority and in Lincoln Park and Spirit Valley,” she added.

Additional information is available on the Internet. Click here  or here.