Opportunity zones and investment in metal fabrication

Kevin Hassett, now head of President Trump’s Council of Economic Advisers, grew up in Greenfield, Mass., a papermill town that has suffered like many other papermill towns. He recalled Greenfield Tap and Die, a large tooling shop that served the surrounding mills. When the mills faltered, so did Greenfield Tap and Die.

“Greenfield Tap and Die, which had previously employed thousands of people, was down to almost nobody. There were papermills along the Connecticut River, on either side of town, that were shutting down. And most of the kids that I grew up with were pretty pessimistic about it all. Most people ended up leaving town.”

Hassett told this to Stephen Dubner, host of NPR’s Freakonomics Radio podcast. Hassett has been a proponent of a new tax policy that aims to spur investment in distressed communities like Greenfield. They’re called opportunity zones, hidden gems in the new, sprawling tax law that, if implemented with clear regulation, could benefit metal fabricators and other manufacturers, small and large alike.

Since growing up in Greenfield, Hassett has seen money pour into urban areas, especially along the coasts, with huge, seemingly continual investments in health care, finance, and high-tech. Over the decades, the talented and ambitious have fled from the heartland, with its closed factories and mills, and toward places like Silicon Valley and New York. They followed the money.

Opportunity zones could, albeit in a small way, help reverse this trend. Hassett and others have said that these zones are an experiment, and they won’t by themselves lift distressed communities everywhere. But they may help nudge people to invest in things they otherwise wouldn’t.

“Each state governor was given an opportunity to nominate a portion of what are known as ‘low-income communities’ as opportunity zones. That process has occurred, so most if not all states have opportunity zones certified through the governor and the secretary of treasury.”

So said opportunity zone specialist Jonathan Katz, a partner at Jones Walker LLP’s Tax and Estates Practice Group in New Orleans (www.joneswalker.com). “It essentially incentivizes investment in low-income communities through the deferral and partial elimination of gain incurred in connection with the sale or exchange of property.”

Before going further, here’s a disclaimer: All this is for informational purposes only, and because the IRS is still writing many of the regulations that interpret the tax law, many questions still are unanswered, including how other aspects of the law (new rules for bonus depreciation and net-operating-loss limits, for instance) will affect the tax benefits under the opportunity zone program. For the specifics, seek out your tax professional.

With the disclaimer out of the way, here’s how the opportunity zone tax incentive is designed to work. An investor (person or company) sells property, anything from a business line to stocks. Instead of keeping the money and paying the taxes on the gain, the investor could (within 180 days) put an amount of the proceeds equal to the gain into a qualified opportunity fund, formed as a corporation or partnership for the express purpose of investing in a qualified opportunity zone business or qualified opportunity zone business property.

Once the money is in the fund, the investor can defer his gains until 2026. This, Katz explained, does create what he called “phantom income” in 2026, as an investor must report and pay taxes on that original gain incurred years before even though the fund interest is not sold. Though, as a reward for investing that original gain in a fund, the investor can get a gain discount of between 10 and 15 percent, depending on how many years the money stays invested in the fund. For instance, if someone reinvests a $100,000 stock gain into an opportunity zone fund, he may end up paying taxes on just $85,000 of that gain.

But as Katz explained, that tax payment may be nothing compared to the opportunity zone’s principal benefit: no taxes on further gains from the sale of its investment in the fund after holding the fund interest for at least 10 years. If an outside investor holds on to its fund interest for 12 years, then sells it, the investor generally pays no taxes on the gains from that sale of its fund interest. There are exceptions, but the only taxes he’d generally pay would be deferred gain in 2026.

As Katz explained, “Although there are exceptions, once you cross that 10-year mark, then you will generally not pay taxes on the future appreciation of the fund interest. That’s a very powerful thing.”

Katz described how this opportunity zone tax benefit could work for both large and small transactions. First, he described a large transaction: Berkshire Hathaway (hypothetically) sells a line of business and has a $1 billion qualifying gain; the company then invests that gain in an opportunity zone fund, which can be used for Berkshire Hathaway to build a new manufacturing plant in a qualified opportunity zone. And as described, Berkshire could defer paying taxes on the original $1 billion gain until 2026 and, most significantly, generally avoid paying taxes altogether on all the gains thereafter, should the company decide to sell the fund interest after 10 years.

A large plant investment could spur more suppliers into the area, including many small businesses. So how would the opportunity zone benefit work on a small scale? Katz described a common arrangement in which a small fabrication shop (or any other capital-intensive small business) operates as a partnership, with one partner running the business and the other being “the money person,” an investor with means.

In this case, the small fabricator might decide to expand by opening a plant in the opportunity zone. His investor partner, sensing a peak in the stock market, provides the funds by selling some of his stock portfolio. Instead of paying tax on the gains from the stock sale, the investor partner sets up and sends the money through an opportunity zone fund, which funds the fabricator’s expansion into the low-income area, close to Berkshire Hathaway’s shiny new plant.

Like Berkshire Hathaway, the fab shop investor could defer paying taxes on the gains from his initial stock sale until 2026. And if he holds interest in the fund that owns an interest in the fabrication shop for 10 years or more, he will generally avoid paying any taxes on the gain from the sale of the fund interest, should he decide to sell it down the road.

Will this incentive by itself be enough to make a deal go through? According to Katz, probably not. But it’s at least a piece of the puzzle. How big a piece will depend on how the regulations and other guidance are written. There are many unanswered questions surrounding this program. Still, as answers emerge, this program should provide at least some incentive for investment, which is good news for large and small fabricators alike.

For more on the basics of opportunity zones, visit www.irs.gov and type “opportunity zones” in the search box.