The Detroit area is home to several opportunity zones. (Photo: AP)

There’s one section in the 2017 tax cut legislation that most financial advisors know little about but probably should get acquainted with, especially if they have clients interested in impact investing.

It’s the section that allows the creation of opportunity zone funds, designed to promote economic development in low-income neighborhoods through private tax-advantaged equity investments.

Investors who roll over capital gains into an opportunity zone fund within 180 days can defer those gains until their investment in the fund is sold or until Dec. 31, 2026, when the tax provision sunsets. (see the tax legislation, Section 1400Z ‘‘Subchapter Z — Opportunity Zones”).

In addition, their investments in an opportunity zone fund receive the tax advantage of a stepped-up basis if they are held for five years or longer. At five years the basis is increased by 10%; after seven years 15%; and at 10 years, it’s increased to the market at the time of sale.

The funds are required to invest at least 90% of their assets in designated opportunity zones, in real estate, local businesses and other business assets located in a qualified opportunity zone, issuing stock, partnership interests or business property to their investors. The funds themselves certify that their investments align with the law.

Matt Temkin, a managing member of North Coast Partners, a  real estate investment company, says opportunity zone funds are a good investments “for high-net-worth investors looking to solve tax issues and a chance to do good.” There were roughly $6 trillion in unrealized capital gains as of the end of 2017.

Temkin’s firm is in the process of raising funds for its Detroit Opportunity Fund, which will focus on investing in newly designated opportunity zones in the Detroit area, in which North Coast Partners currently operates.

To date, the Treasury Department has certified more than 8,700 Census tracts across all 50 states plus Washington, D.C., and territories as opportunity zones — zones that were nominated by governors and other chief executives.

Fran Seegull, executive director of the U.S. Impact Investing Alliance, sees the potential benefits of opportunity funds both for investors and communities but says it’s “very early” for investments because more guidance is needed from the Treasury and IRS. “I don’t think there will be a fundraising opportunity until the first quarter of 2019.”

A coalition of more than 40 impact investing groups, including Temkin’s Detroit Opportunity Fund  and the Economic Innovation Group, which helped design the legislation that created opportunity funds, has written a 21-page letter to the acting commissioner of the IRS requesting guidance on a number of issues regarding implementation of opportunity funds. These include the timing for deployment and investment of capital, valuation method to meet the 90% asset test and the definition of a qualified opportunity zone business property.

“There are very few guardrails,” in the legislation, says Justina Lai, director of impact investing at Wetherby Asset Management, an RIA with offices in San Francisco and New York. “The legislation doesn’t require any provision for long-term reporting and there are no protections in place to insure the benefit go to low-income people….[that] gentrification doesn’t dislocate people and businesses.”

For now Wetherby Asset Management will be watching for guidance from IRS. That could be coming as early as the third quarter, according to an interview that John Lettieri, co-founder and president of the Economic Innovation Group, gave to The Associated Press last month.

When the guidance does come and opportunity zone funds are created, advisors with clients interested in these investments need to do their due diligence. They should ask about the investment strategies and target beneficiaries along with how benefits will be tracked and portfolios managed, says Lai.

In addition, advisors also need to remember that eventually investors will need to pay the tax on the capital gains that are initially rolled over into an opportunity zone fund, says Stuart Saft, head of real estate practice at Holland & Knight. Saft says these funds are “conceptually a terrific idea” to help communities and taxpayers, but investors will “still owe capital gains tax on the original investment.”

Moreover, the tax benefits of opportunity zone funds, like many other tax breaks included in the 2017 tax cut legislation,  are due to expire at the end of December 2026, unless they’re extended with new legislation.

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