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Real Estate

Opportunity zone rules aim to draw capital to distressed areas

Boarded up residential buildings stand in the Port Morris neighborhood of the Bronx borough of New York.

It will be easier to invest in businesses and real estate in low-income communities throughout the U.S. now that the Trump administration has released rules for a tax break to encourage economic development in distressed areas.

Wall Street banks, private equity firms, real estate developers and others have been eagerly awaiting the regulations, which the administration says will spur $100 billion of investment into the more than 8,700 areas designated as "opportunity zones" in the 2017 federal tax overhaul.

The 169-page proposal give funds interested in these areas additional leeway to invest capital on a more flexible timeline, a Treasury official told reporters Wednesday. The rules also give investing funds a one-year grace period to sell assets and reinvest the proceeds, thus avoiding penalties intended to prevent funds from sitting on the cash.

The new Treasury regulations give funds six months from when they receive money to purchase assets that qualify for the special tax breaks. The rules also allow land and vacant buildings to be investments eligible for an opportunity zone fund, the Treasury official said.

While there's been a flood of interest in opportunity zones, many people have delayed investments to see if the rules make sense for the projects and businesses they have in mind. Skeptics of the provision will be looking for guardrails in the regulations to prevent investors from claiming a generous tax break for developments that do little to help the poor.

Investors are racing to meet deadlines in the law that require them to invest their capital gains income within 180 days of selling the stock or business.

The rules permit more flexibility to include more than one investment in a fund, the official said. Investors would like to create multiasset funds to reduce the risk of a single bad project wiping out any return. The rules allow investors to get special tax treatment if they've held their stake in the fund for at least 10 years, even if the fund didn't own the asset for a full decade, the official said.

Investors can also buy into a fund by directly purchasing an interest or buying another partner out.

Tax breaks

Investors claim the breaks by taking capital gains income they've already earned and deploying it in the distressed areas. The provision, part of the 2017 Republican tax overhaul, allows them to defer those tax bills until the end of 2026 and can reduce the total amount of tax they owe. The new investments in the opportunity zone can grow tax-free if investors hold them for at least a decade.

Several prominent investors, such as Goldman Sachs Group (GS), hedge fund EJF Capital and New York-focused RXR Realty, have already begun making investments in opportunity zones or are raising money to do so. These funds are rushing to invest in some urban areas most likely to produce large returns.

Some critics argue the law is written so loosely it could become a handout to the wealthy, juicing returns on projects they would have pursued anyway. Others say that the bulk of investment could go to zones in places like Brooklyn and Portland, Ore., that have little trouble attracting investment.

The White House is hosting about 20 governors and several hundred local leaders Wednesday to discuss how the tax-incentive program is working in their communities. The most recent rules follow regulations from October to instruct investors on how to qualify for the tax breaks.

The regulations also address a problem flagged by many investors looking to create startup businesses: the requirement that businesses generate at least half their gross income within their opportunity zone. That works for an apartment building or a grocery store, but would be a disaster for a business hoping to manufacture a product to be sold widely, or provide services online.

The rules give funds three different ways to prove that they are conducting enough business from within the zone. Treasury will allow businesses to qualify if at least 50% of the hours the employees work are within the zone, as long as it performs at least half of the its services within the area, or if there are significant management and operational functions present. Businesses can also appeal their specific case. Fifty percent of the sales do not have to come from within the geographic zone, the official said.

This round of regulations doesn't impose reporting requirements that would allow the IRS to assess penalties on those who violate the rule. The Treasury Department released a document Wednesday soliciting public input on how to best measure economic activity in opportunity zones and how to collect this information.

Sens. Cory Booker, a New Jersey Democrat who's seeking his party's presidential nomination, and Tim Scott, a South Carolina Republican, are planning to introduce legislation that would require the IRS to collect data from tax break recipients to show how investments are altering the economic conditions in the areas where they operate.

Messrs. Booker and Scott were both early backers of opportunity zones in Congress before the provision became law. Their law would require the IRS to compile data about how many funds have been created, what assets they own, how many jobs have been created and how poverty levels have changed.