You wouldn’t normally put Kona and Oz together, but that’s about to change. The new Investing in Opportunities Act, legislation with a significant community benefit upside, establishes OZ (Opportunity Zones) here on the Big Island. Although final IRS rules are still pending, the road to OZ investment is available here now and has some real economic potential.
The intent of the Investing in Opportunities Act was to incentivize private investment in low-income communities through favorable tax treatment on investments in what are called Opportunity Zones. This provides an important tool for certain communities in attracting investment by freeing up money that might otherwise never become available and directing it to where it is needed the most. This is important because one of those communities is Kona.
There has been an investment vehicle based on new market tax credits that has been around for a while that functions by making investments in areas classified as low-income census (LIC) tracts. Based on wildly complicated financial machinations, investments in those tracts receive beneficial tax treatment. The OZ scenario takes 25 percent of those same census tracts in each state plus a small percentage of adjacent tracts and designates them as Opportunity Zones. There are more than 8,700 OZs in the US. Two of them are in Kona and four are in Hilo. In Kona, those two tracts run approximately from the ocean, up Hina Lani Street to Mamalahoa Highway and stretch south along Hualalai Road and Kuakini back to the ocean (see invest.hawaii.gov/hawaii-opportunity-zones for the map). This area includes the new industrial area and essentially all of downtown Kona.
In the normal course of investing, when you make an investment that does well, hold that investment for longer than a year, and then ultimately sell it and make a profit, that profit is subject to long-term capital gains tax. Based on your tax bracket you pay tax on that profit along with the tax you pay on your regular income, but at a different rate.
Investing under the provisions of the Opportunity Act means that instead of paying taxes on capital gains when you realize a profit, putting that money in an Opportunity Zone investment and holding on to it for five years lets you defer 10 percent of it from taxation. If you hold onto it for two more years, you can defer an additional 5 percent. So that’s good for the taxpayer involved in that all-American pastime of tax planning; not great, but good. The real prize behind the curtain in OZ is that if you hold on to the investment for 10 years, not only do you defer 15 percent of it from capital gains tax, but you pay zero tax on any profit you make from that investment. Zero.
One way to invest in an OZ is through an opportunity fund managed by a commercial fund manager, and these are popping up throughout the country, some of them targeted to certain geographical areas. The other way is to form an entity that you designate as an opportunity fund and invest in an OZ project. This is important because what this means is that virtually anybody can form a legal entity with the purpose of investing in an OZ, characterize it as an opportunity fund with the IRS, carry through on that intent with 90 percent of its capital, and achieve the tax savings OZ investment offers as long as “substantial improvement” in the project is realized. There is apparently no oversight (other than audit one would suppose), no significant barriers to entry into such a fund, and really no mechanism for tracking the aggregate outcome of investments made in this way.
Now, this being a very imperfect world, that’s bad and good at the same time. It’s bad because there are witches in Oz who can be expected to partake of the unexpected consequences of this new vehicle to enrich themselves further. It’s good because this presents what could potentially be a windfall of investment in certain communities needing access to investment capital, like the designated LIC tracts in Kona. It’s also good because in its marketing of OZ the community can designate and pursue the types of development it would like to see in the area.
In Hawaii, the Department of Business, Economic Development and Tourism (DBEDT) has been tasked with the coordination and marketing of Opportunity Zones with the counties; check out the DBEDT website for more information and for notice of the local outreach event planned for early 2019.
This being a tax tool, there are tons of details and caveats to this investment vehicle, and some unknowns until the IRS issues final rules, so you need to check with your legal and financial advisors before considering this option. But OZ investment is open for business now and offers Kona an opportunity to pave its road to the future.
Dennis Boyd is the director of the West Hawaii Small Business Development Center, funded in part with the U.S. Small Business Administration and the University of Hawaii at Hilo.
