As tax policy experts dissect federal tax legislation enacted last year, one provision that is gaining increased attention may hold special promise for Puerto Rico: Opportunity Zones.
Opportunity Zones are low-income areas that offer financial incentives to potential investors. The goal is to build up distressed communities. Areas must have at least a 20% poverty rate to be nominated to be an Opportunity Zone, and the average income must be lower than 80% of the state’s median income.
States have a limited number of areas that may be classified as on Opportunity Zone, but the entire island of Puerto Rico is, by default, designated as an Opportunity Zone.
Why is being designated an Opportunity Zone potentially a good thing for Puerto Rico? It comes with tax deals that should be appealing to investors. Unrealized capital gains are typically held in mutual funds or stocks and bonds. Investors can now sock them away in Opportunity Funds, a new class of investment vehicle.
“Investors can roll unrealized capital gains tax-free into Opportunity Funds,” point out Ryan Ellis and Cesar Conda in a recent opinion piece in the Washington Examiner.
Investors sitting on unrealized capital gains get tax deferral when they roll those gains into Opportunity Funds. Keeping the money invested for seven years lets them step up their basis by as much as 15%. If they keep those funds in Opportunity Funds for ten years, they don’t even have to pay capital gains tax on the sale.
How is this different from earlier tax incentives?
Puerto Rico has previously had tax incentives for investors, but those incentives have generally resulted in a wash through, leaving little actual investment on the Island. Corporations were able to make very limited investments resulting in few jobs, for the primary purpose of avoiding taxes.
Opportunity Funds are a new type of investment vehicle. They could provide capital for housing, small businesses, and infrastructure. Financial institutions are expected to offer these funds to their clients not only for a means of managing capital gains, but also as a stable, tax free long term investment.
“That means that any investment in Puerto Rico—which is a part of the United States and enjoys the same property rights and other legal protections as anywhere else—is now a tax free activity for those who commit to keep their capital there,” say Ellis and Conda. “Just imagine the chance investors have to buy low: a decade of debt crises, fiscal mismanagement, power outage issues, and hurricanes has knocked Puerto Rico off her feet. But this is prime American real estate, just ready to be bought at a bargain. Businesses should be eager to set up shop there and provide superior services to the 3 million American citizens still living on the island.”
The US Department of Treasury is developing regulations to govern Opportunity Funds, and financial institutions will then be able to set up investment vehicles under those rules. The Economic Innovation Group estimates that some six trillion dollars could be available for investment in Opportunity Funds, and hopes to see action taking place by this summer.
“If they work,” Conda and Ellis conclude, “Opportunity Zones can be the difference between an America where too many get left behind and one where the benefits of our prosperity can truly be shared by all.”