Can Tax Credits and Opportunity Zones Be Combined?
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SUMMARY: Low-income neighborhoods have received government boosts through the opportunity fund program and tax credits. Investing in opportunity zones through real estate projects positions you to qualify for credits, such as the low-income housing tax credit (LIHTC). Low-income neighborhoods have long suffered from development efforts in favor of more up-scale regions across the US. The opportunity fund was enacted through the Tax Cuts and Jobs Act to overcome these challenges and divert meaningful resources towards places designated as opportunity zones and in projects such as real estate. These same regions are eligible for more government incentives such as tax credits that allow investors benefits for channeling funds towards these areas. Investors then wonder, and inevitably so, whether it is possible to combine these incentives and whether they lead to greater overall benefit. Opportunity Zones OZ are regions identified as low-income by the US government and need economic development. Their characteristics include low household income, low education, higher unemployment, higher poverty levels, and greater negative externalities such as crime. These neighborhoods' demographics mostly consist of minority groups and people of color. To qualify for the fund, you must invest at least 90% of the entity's assets in an opportunity zone. You must file an annual partnership or corporation federal income tax return and submit the IRS Form 8896.
Tax Credits The US government offers various tax credits to investors to have them invest in low development areas. These credits include: The Low Income Housing Tax Credit (LIHTC) This was developed as part of the Tax Reform Act 1986, seeking to address the gap between housing demand and supply. The goal was to encourage real estate developers to design housing for individuals with income below the Area Median Income (AMI). The program offers nonrefundable and transferable tax credits that subsidize construction and rehabilitation costs for housing projects. The IRS gives these credits to Housing Finance Authorities at the state level, which creates the eligibility guidelines. The New Market Tax Credits (NMTC) The NMTC works by allowing private investors a tax credit against their federal income tax if they have equity investments in Community Development Entities. This credit is 39% of the original investment amount and is claimed over seven years. What are Community Development Entities? CDEs take loans or make investments. They apply to receive tax credit authority from the Treasury’s Community Development Financial Institutions (CDFIs) and sell these credits to investors. They use the money to make debt or equity investments in qualified lowincome communities. CDEs use other subsidies and private sector funds to invest in projects and leverage the NMTC. Can Tax Credits and Opportunity Zones be Combined? There are no clear statutes limiting an investor from combining the benefit of an opportunity zone and a tax credit. Often, if an entity is eligible for both incentives, it can apply for both and stand to gain joint value. However, the combination is not always seamless. Opportunity zones are relatively new in the market, and many investors are on their first projects, learning their way around the regulations. Tax credits such as the LIHTC have been around for decades, and the disparity is likely to cause conflict. Moreover, LIHTC investors are likely to be institutions such as banks driven by motivations such as complying with the Community Reinvestment Act. On the other hand, OZs will likely be funded by high-net-worth individuals or people looking to protect their capital gains or reduce or defer taxes. If you seek to combine the benefits of these two programs, consider that it may not be entirely smooth sailing. However, when well implemented, combining tax credits and opportunity zones should have phenomenal benefits to investors and the community.