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Zoning in: Tax break could offer additional lift to urban redevelopment

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The Wolf administration identified 300 opportunity zones, or distressed areas where investors can get a tax break.
The Wolf administration identified 300 opportunity zones, or distressed areas where investors can get a tax break. - (Photo / )

Joe Wagman has long been involved in re-developing a tract near downtown York known as the Northwest Triangle. A multiphase project has been moving along at site, with various phases completed as part of an effort to transform vacant lots and dilapidated buildings into a walkable neighborhood of retail, commercial and residential buildings that will connect with the city's downtown.

The long-term project has involved multiple stakeholders from the private and public sector who have cobbled together a mix of private financing and public grants to ensure the properties get a new life. Now, more help could be coming from the Trump administration’s tax overhaul, which became law in late 2017.

A provision of the tax law created a vehicle that investors can use to get a tax break on capital gains by investing in projects in distressed areas – primarily in cities – nationwide. They are called Opportunity Zones

In Pennsylvania, the Wolf administration has identified 300 Opportunity Zones. Northwest Triangle is among them. Others can be found in Lancaster, Reading, Harrisburg, Allentown and Bethlehem, as well as other cities and even some rural areas of Pennsylvania.

“We are cautiously optimistic that it will help,” said Wagman, chairman of Wagman Construction, which has operated in York County for four generations.

Wagman is cautious partly because the federal law is so new that the experts still are figuring out the best way to tap into it. In addition, he knows how difficult it can be to attract investors to risky projects in distressed areas, which is the focal point of the Opportunity Zone program. That challenge is especially tricky for smaller cities, where taxes tend to be high and the costs of construction are only slightly lower than in large cities – but developments cannot command top rent, he said.

The federal Opportunity Zone program was passed as part of the 2017 tax overhaul championed by the Trump administration. This program is intended to help economically distressed areas by offering additional tax incentives for development.

The state, through the administration of Gov. Tom Wolf, has identified 300 areas statewide that will be eligible for the incentives, and most of the parcels are in urban areas. Nationwide, there 8,700 qualified zones. One can view an interactive map of available parcels, pictured above, on Pennsylvania’s Department of Community & Economic Development website.

Some positives of the tax program, according to accounting experts, include the following:

  1. The program helps distressed communities.
  2. For investors, capital gains on a current investment can be deferred for years.
  3. There is no cap on the amount that can be invested in a Qualified Opportunity Fund.
  4. A fund can be created relatively easily through self-certification that involves filling out a form.
  5. Taxable capital gains invested in the fund can be reduced 10 percent after five years; after seven years, there is an additional 5 percent cut. That means that a $100,000 capital gain put into a fund would be taxed at $85,000 after seven years. By Dec. 31 2026, taxes would have to be paid on that original investment but at the $85,000 level. However, after 10 years, the capital gain created by the Opportunity Fund would not be taxed.
Experts also cautioned that the new law has several potential downsides:
  1. The right investor will need to be someone who has a capital gain to begin with but then is willing to invest long-term in a real estate venture.
  2. They must do so within 180 days of getting the capital gain.
  3. Because it is a long-term investment, the potential for the tax laws to change before the full benefits are realized is increased. The investment assumes that a profit will be made. As with any investment, a profit is not guaranteed.
  4. The product targets distressed areas, which makes any investment that much riskier.

That dynamic makes it difficult for developers to make investments unless there is significant help.

The Northwest Triangle project, for example, received a $6 million state grant in June, Wagman said. The new federal tax law is one more tool that might help push investors off the fence, he said.

“It takes everything available,” Wagman said.

The ideal investor who might benefit from the tax law probably is someone familiar with the risks and rewards of real estate but who also has a community spirit and would like to see distressed areas turn around, observers noted.

“I think it is going to help motivate investors to look for solid projects,” Wagman said. “People are waking up to the opportunities that these zones create.”

Observers, including Wagman’s tax adviser Michael Eby, said the basic plan will work like this: An investor can take capital gains from any source and re-invest the money in a Qualified Opportunity Fund, thereby deferring taxes on that capital gain. The funds themselves must invest in projects in Opportunity Zones. After five years, the taxable share of the capital gain is reduced 10 percent, and after seven years it is reduced an additional 5 percent, said Eby, who is senior tax manager for McKonly & Asbury LLP, in Camp Hill.

So, if an investor sinks $100,000 in capital gains into a fund and waits the full seven years, he or she would owe taxes on $85,000. The law provides for further tax breaks and incentives if the money is invested in the fund for more than 10 years, including not having to pay taxes on any gains from the investment in the fund.

More is being written and discussed about the new law, Eby said, so interest is rising as experts figure out the best ways to put plans into action.

“You are hearing a lot more about it now,” he added.

Several certified public accountants contacted about the new tax law pointed out that the benefits could be extraordinary for the right investor.

“There is a lot of benefit to doing it,” said Deborah S. Rock, a CPA and consultant in RKL LLP’s tax services group.

Rock agreed with Wagman’s assessment that the benefits to communities might make the tax plan particularly attractive to investors with deep roots or strong ties to a town or city, but she noted that there are no restrictions that require someone to live or work in the community where an investment is made.

“The purpose is to spur investment in economically distressed areas,” she said. “It’s an investment that can make a difference.”

When the state announced which census tracts would be eligible to become an Opportunity Zone earlier this year, Harrisburg officials were eager to see how the incentives would be fleshed out, said Jackie Parker, economic development director of the capitol city. But city officials have yet to see concrete plans put into place that would take advantage of the program, she said.

David Black, president and CEO of Harrisburg Regional Chamber and Capital Region Economic Development Corp., said the tax incentives eventually could help with his organization’s efforts to redevelop an industrial property near the Harrisburg train station. That project still is in the environmental study phase and probably will be for at least another year, at which time the project would be turned over to developers who likely would tap into the new tax incentive, he said.

He pointed out that Lancaster-based Community First Fund has taken a lead in sorting out the next steps for using the tax incentives for various projects in Harrisburg, Lancaster, Reading and York. Daniel Betancourt, president and CEO of Community First Fund, said his goal is to establish a Qualified Opportunity Fund that investors can seed and then have the money used for various projects in those communities. According to an IRS website, the process to become a qualified fund involves self-certification by filling out a form.

Community First Fund has a deep history of facilitating redevelopment projects throughout Central Pennsylvania, he said, and that experience should help attract investors looking to take advantage of the new tax law. One goal now is to spread the word among accountants and tax attorneys, as well as other organizations that could benefit from the tax breaks – or at least an investment in the funds, he said.

John R. Steffee, a partner at Simon Lever in Wormleysburg, said the incentives are attractive but cautioned that, as with any investment, there are potential downsides. For one, seasoned real estate investors know that markets can shift dramatically, he said, so such investments are not for everyone. In addition, tax laws can change. Then there is the basic rule of investment: not every venture makes money, he said.

“It doesn’t guarantee a profit,” he said. “But if you do make a profit, it offers a significant tax incentive.”

For Wagman, any incentives that help cities rebound is money well spent. Newer generations aren’t as interested in cars and suburbs and want walkable cities with interesting features. The public and private sectors must figure out the best ways to transform cities, especially smaller ones like York, if they are to compete with larger cities, he said.

“There is broad recognition in today’s world that you have to have a vital urban core… with good-paying jobs,” Wagman said. “We have to have attractive urban offerings. That’s very, very critical to moving the city forward ... And we need every break we can get.”

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