The Land of OZ
By Jerome A. Breed
6 min read
The Trek From Statute to Policy
As you have read in these pages, the Tax Cuts and Jobs Act of 2017 enacted a new incentive for community development, the Opportunity Zone Program found in Internal Revenue Code Sections 1400Z-1 and -2. The Opportunity Zone Program (OZP) is intended to direct investment into economically distressed census tracts by providing for a deferral of federal income tax on capital gains recognized within 180 days of the investment into a Qualified Opportunity Zone Fund and an exclusion of all capital gain realized on Opportunity Zone investments that are held in excess of ten years. Rarely has a new tax statute generated more technical questions as to its interpretation and application to actual transactions. Unfortunately, little guidance has been issued by Treasury to generate investor confidence in Opportunity Zone transactions. For example, the most recent “guidance” came in the form of draft tax return forms that made it clear that participation would be limited to “capital gain” and that gain characterized as ordinary under the depreciation recapture rules would not qualify. An initial set of Treasury regulations regarding Opportunity Zones has been drafted and reviewed by the Office of Management and Budget, but has not yet been released as of October 15, 2018. We anticipate that the pending guidance will address a number of the central OZP issues, but also expect that a large number of significant issues will remain. Given the short time between now and the end of the year, we assume that the volume of Opportunity Zone transactions closed in 2018 will be substantially less than was predicted earlier in the year. The delay in closings will postpone the creation of jobs and beneficial economic impact in some of our poorest communities.
The current holding pattern triggers reflection regarding the process by which promising new statutes grow into beneficial programs. First, there needs to be open dialogue between the rule makers, IRS and Treasury, and the private sector. Problems encountered in the field and in the analysis that is done to close transactions should be shared with those writing the rules and the rule makers should actively seek the benefit of the experience gained by practitioners as they implement new statutes. This dialogue will inform the rule makers as to the real issues, and can provide valuable suggestions as to the resolution of points that arise under the statute. Open discussion yields better results than closeted contemplation.
In the initial promulgation of rules under a new statute, Treasury should provide guidance that can immediately be relied upon. Proposed regulations do not constitute effective guidance. Proposed regulations are both subject to change in further guidance and may be disregarded by a court of law. Regulations that are both proposed and temporary constitute a much more effective set of initial guidance. Such regulations provide a comment period for private sector input and reaction while simultaneously providing immediate, binding rules that can guide activity and upon which taxpayers may comfortably rely. Second wave guidance issued after the initial set of guidance should be prospective in application. Only by making it clear that subsequent guidance will be prospectively applied will taxpayers have comfort that their interpretation of open questions will not be transformed into retroactive “gotcha” tax administration. If pioneers are shot in the public square, the settlers won’t follow. Pronouncements as to the effective date of future guidance could take the form of public statements by Treasury and IRS officials or even better, by written statements included in the explanation of the initial guidance when it is issued.
The National Association for Opportunity Zone Investment is a newly created trade association that has submitted a comment letter to Treasury and is advocating both positions to be taken on the law prior to the issuance of guidance and the commitment that any subsequent guidance will be issued on a prospective basis. I believe that the industry should adopt a similar view in its interactions with IRS and Treasury. The assurance of prospective application of future guidance will go a long way to unlock potential investment dollars that are sitting on the sidelines. Unlocking investment dollars in 2018 will kickstart the receipt of Opportunity Zone benefits in neighborhoods that sorely need to catch up to the economic resurgence being enjoyed in more profitable census tracts.
The enactment of the Opportunity Zone statute provides an opportunity to reflect upon the drafting of statutes. The OZP continued the common practice of granting Treasury authority to promulgate regulations that would guide the interpretation and application of a statute. Given the increasing difficulty in securing guidance from Treasury with respect to community incentive tax programs, legislative proponents may decide that it is better to establish time periods and definitions in the statute, rather than waiting for administrators to determine the result. To this point, participants in Low Income Housing Tax Credit transactions have been waiting ten years for the IRS to issue guidance that will define the word “substantially” in the context of acquisitions of buildings that are subsidized under certain federal housing programs. Proposed regulations issued with respect to partnership redemptions under the New Markets Tax Credit program have yet to be finalized years after issuance. In light of these substantial delays, Congress should be more comprehensive in its statutory drafting, and private sector champions of proposed legislation should bite the bullet and make more decisions upfront rather than relying upon administrative bodies to issue post-enactment guidance.
Moreover, in the past, Congress would take up technical corrections legislation after the passage of major tax legislation to improve and fine-tune statutes after private sector participants uncovered glitches in applying the new law to actual transactions. The Low Income Housing Tax Credit program was the beneficiary of technical corrections in 1987, 1988 and 1989 after its enactment in 1986. These technical corrections included the concept of carryover allocations, among others, without which the program would have failed. Unfortunately, in the current political environment, technical corrections are more difficult to obtain.
To transform the Opportunity Zone statute into a program that will last, technical corrections will be necessary. For example, the 2026 end of deferral with respect to the triggering recognition of gain should be moved back each year to achieve the same level of subsidy for transactions closed after the end of 2018. Moreover, a reporting obligation needs to be added to the statute so that Treasury and Government Accountability Office (GAO) can measure the success of the program. Without reporting, the proponents of the program will not be able to comprehensively analyze OZP results. Once the puzzle of closing initial transactions is solved, the community of Opportunity Zone participants should come together to consider how to transform a promising statute into an established and effective program.
