The Land of Opportunity Zones: Deferring Taxable Capital Gains through Investments in Low-Income Communities

By Vardell, Reid S. | Missouri Law Review, Summer 2019 | Go to article overview

The Land of Opportunity Zones: Deferring Taxable Capital Gains through Investments in Low-Income Communities


Vardell, Reid S., Missouri Law Review


I. INTRODUCTION

The market reserve of unrealized capital gains in the United States has grown to an estimated $6 trillion. (1) A new program provides a novel way to incentivize investors into realizing those gains but deferring recognition, while at the same time helping to revitalize areas of America that need it most. (2)

The opportunity Zone Program is a tax deferment scheme that serves as a tool to bring capital into underperforming areas (3) by giving preferential tax treatment to realized capital gains reinvested in specific communities. (4) The program aims to remedy the "profoundly uneven" economic recovery in the United States following the Great Recession of December 2007 to June 2009 where many areas still face high unemployment and low job opportunity despite robust economic recovery in more resilient urban areas. (5) When jobs leave an area and unemployment increases, private investments and businesses start to move elsewhere. (6) This causes a hollowing out of the area's tax base and a decline in revenue for local governments. (7) Many workers stay in these distressed areas of high unemployment either by choice or necessity, (8) which places a higher burden on the local government and established social safety nets. (9) Economic concerns aside, workers in these distressed areas face higher instances of death or major illness, and their children are confronted with lower achievement outcomes and wages later in life. (10) Many communities find themselves in this widening gyre where investors are reluctant to return to an area because of the lack of other investors. (11) Congress designed the Opportunity Zone Program as a tool to drive private equity capital back into these under-performing areas and jump-start the economic recovery process. (12)

This Note provides a discussion of the capital gains tax as a backdrop to the Opportunity Zones Program now found in Section 1400z of the Internal Revenue Code (the "Code"). The Note then examines aspects of the program that could lead to the program's success as well as some issues that could delay the program's adoption. Finally, the conclusion will juxtapose the Opportunity Zone Program with the New Market Tax Credit (the "NMTC") to evaluate the program's potential for overcoming past hurdles.

II. LEGAL BACKGROUND

The United States first introduced an income based tax to offset the mounting cost of the Civil War. (13) It was not until the ratification of the Sixteenth Amendment to the Constitution that the concept of a federal income tax became a cornerstone of American taxation. (14) At the time, the Code taxed all income at the same rate, regardless of its source. (15) This changed with the passage of the Revenue Act of 1921, which granted capital gains a substantially more favorable rate than ordinary income. (16)

Capital gain is realized "from the gain on the sale or exchange of a capital asset." (17) If the sale or exchange results in a loss, a capital loss is realized instead. (18) Realized gains or losses generally must be recognized at the time they occur unless some non-recognition provision can be found in the Code. A capital asset is any "property held by the taxpayer," subject to a number of exceptions, including inventory, property used in a trade or business subject to depreciation, all real property used in a trade or business, and patents or inventions in the hand of the creator. (19) In the words of the Internal Revenue Service, "Almost everything you own and use for personal or investment purposes is a capital asset." (20)

Capital gain or loss is generally the difference between the amount the taxpayer receives for the asset and the taxpayer's basis in the asset. (21) A taxpayer's basis in a capital asset consists of costs paid to acquire the asset increased by capital expenditures made to improve it. (22) Capital gains are long-term if the asset is held for over one year or short-term if the asset is held for one year or less. …

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