Why Opportunity Zones Are Failing

The report recommends that federal policymakers expand the program’s incentives to help with the economic recovery after the COVID-19 pandemic and address economic inequities, especially in African-American communities.

Here are the key shortcomings uncovered by the Urban Institute:

• Difficulties for mission-oriented project sponsors in gaining access to and attracting the interest of potential opportunity zone investors, such as family offices, high net worth individuals and others with capital gains that could be deferred by investing in OZs;

• A mismatch between investors, who feel the 10- year investment period needed to gain the most tax savings is too long, and communities, who feel that such a time frame is too short to deliver sustainable economic gains; under the 2017 law, investors in OZs receive a stepped up basis to market rate price when selling these investments, which eliminates any capital gains;

• Lack of OZ funds flowing into neighborhood businesses, even though the zones were created to spur job creation, with most OZ funds financing real estate developments; such shortcomings are tied to design constraints and investor preferences, as well as to the fact that some small businesses don’t want to sell equity in their firms;
• Inadequate investment incentives to spur development in communities that have a greater need for OZ funds; some developers told researchers that they would have proceeded with their OZ projects even without the OZ tax incentives. 

Changes the Urban Institute recommends federal policymakers make, to correct these “structural barriers” and help sponsors realize the full potential of using OZ investments, include:

• Redesigning the program to increase support for investments in small businesses; instead of pure equity investments, the program could include subordinated or hybrid debt or equity products for small businesses, as well as greater flexibility about rules for mission-driven funds specializing in small business investing.

• Targeting incentives for investments with the greatest impacts, rather than providing largest incentives for the most profitable projects; tax incentives could be based on the number of quality jobs created or on other measurable outcomes, for instance.

• Allowing investors who don’t have prior capital gains to invest in opportunity zones; such individuals could receive refundable tax credits, while foundations and endowments could be provided with other incentives.

• Permitting equity investments in community development financial institutions (CDFIs), which have a long track record of making substantial investments in low-income communities. 

–Related on ThinkAdvisor:

• IRS Extends Key Opportunity Zone Deadline
• How to Reduce Clients’ Taxes While Providing a Social Good
• Opportunity Zone Funds: Will They Provide the Impact Investors Expect?
• Opportunity Zones Under Fire in Congress