Perspectives: Opinions from our network of advisors, investors, operators and analysts on the risks and opportunities they see.

The US Treasury Department on April 17 issued its final clarifications on how the community development program known as “opportunity zones” will function, what kinds of projects qualify and how the generous tax breaks on offer will operate. The program, signed into law in 2017, allows individuals and businesses to shelter capital gains by investing in economically distressed communities that were chosen by state governors in 2018.

The latest guidance expands the types of development eligible for the tax credits from residential and commercial to include energy, infrastructure and various environmental projects. It also clarifies the deadlines for investing, in effect giving some investors an extra 180 days or until June 1 to take advantage of the tax benefits.

Opportunity zones were the brainchild of Steve Glickman, a senior White House economic and trade advisor during Barack Obama’s first term. After leaving government in 2013, Glickman teamed up with Napster founder Sean Parker to form the Economic Innovation Group (EIG), a research organization that ultimately shepherded the Opportunity Zone concept through Congress and into law in 2017.

Now running his own consultancy, Develop LLC, Glickman is advising some of the largest real estate investment funds in the world as they vie for the unprecedented capital gains benefits afforded by the law that Steve and his team drafted. The program is also unprecedented in its scope: Some 8,700 opportunity zones chosen by the 50 U.S. state governors — as well as nearly the entire island of Puerto Rico – cover almost 12% of the U.S. and are home to more than 35 million people.

Glickman spoke with Karma Network’s Contributing Editor Michael Moran.

Michael Moran: Where do you see the potential of opportunity zones?

Steve Glickman: Opportunity zones are really an unprecedented attempt to build a new industry in private capital markets based around long-term growth investments into distressed areas of the country.

Tapping into private equity capital markets make Opportunity Zones different from any other community development program we’ve seen in recent U.S. history in that the program doesn’t rely on a set of heavy-handed government incentives on the front end. The result of that is you can leverage far more investment and move far more capital.

Michael Moran: What are the main incentives for investors?

Glickman: Opportunity Zones are comprised of three interrelated capital gains incentives. To start, in order to take advantage of the program as an investor, you need to have existing capital gains. The first incentive is that the Opportunity Zones program allows you to defer or roll over capital gains into Opportunity Zone Funds. The benefit of doing that is you defer paying that capital gains tax until the end of 2026.

The second incentive is that investors can qualify for up to a 15% discount on that capital gains tax bill depending on how long you invested (at least five years for a 10% discount or seven years for a 15% discount).

The third incentive is by far the biggest, most impactful aspect of the program. For investors that hold their stake in an Opportunity Zone Fund for 10 years or more, any profits you make through those funds are tax free. Opportunity Zones are the only capital gains incentive in the tax code where you get total forgiveness on capital gains taxes without having to die first, which is a big benefit of this program.

Michael Moran: What do you make of the Treasury’s latest rules and clarifications on what qualifies as an Opportunity Zone project and how things would play out in practice?

Glickman: This latest, and potentially final round of regulations released by the IRS, is really a game changer for the industry. Many of the open questions over the past several months have received pretty good answers that will, for example, enable multi-asset funds to be totally viable and ensure asset classes outside of real estate will be able to access opportunity zones. This new clarity is going to trigger a huge amount of investment activity and the launch of new funds before the end of the year.

The two rounds of regulations have clarified there are two extended deadlines by which you can deploy certain types of capital gains. If your capital gains come from private business investments or public equity markets, you have 180 days to roll over gains to a new fund from the day you realize it – in other words, the day you sell an asset. But if you get your capital gains through a partnership or from most real estate assets, you get 180 days from the end of your taxable year. So that means the end of June each year will be an important deadline for many investors. I think there will be lots of investors who thought their clock to roll over capital gains in 2018 had expired, and will now learn they have two more months to deploy that capital.

Another deadline is that there is a small cliff at the end of 2019: Of that maximum 15% discount on an investor’s deferred capital gains, 5% will go away if you don’t invest by the end of the year. While that doesn’t usually mean a lot to the overall returns of these funds, it does seem to be a motivating factor, especially for tax-sensitive investors who want to fully maximize the incentive.

Michael Moran: How did the actual zones get chosen? I’d imagine there was a lot of jockeying for these designations. What was the methodology there?

Glickman: It started with a federal standard that designates areas as Low-Income Community Census Tracts. This standard has been around for a long time and is defined as any census tract in the US where residents earn less than 80% of the state’s median income or where over 20% of the tract’s residents are below the federal poverty rate. When you do the math, it somewhat shockingly equals about 40% of the country.

Congress then empowered the governors of every state and territory to select 1 out of every 4 of their Low-Income Communities as Opportunity Zones. Those selections were finalized by the Treasury Department last June, culminating in over 8,760 Opportunity Zones, covering 12% of the country and 35 million Americans.

Michael Moran: Let’s talk about this from a fiscal standpoint. One could assume many of these places are inert at best in terms of generating tax revenue. But if I’m a governor or if I’m the IRS, I need to do the math on cost-benefits. What do these zones do to the fiscal picture at the state and the federal level?

Glickman: From a federal standpoint, Opportunity Zones accounted for a very inexpensive hit on the budget. It only cost about $1.5 billion over ten years, making it twenty times cheaper than its closest cousin, the New Markets Tax Credit. And remember: This is a federal capital gains tax incentive, so from the standpoint of a governor, the impact on state revenues fairly limited.

About 30 states, including New York, conform to the federal tax treatment, so you get the Opportunity Zones benefits on the state capital gains taxes as well. About 10 states have no capital gains tax at all, so this program would have no impact on them from a revenue perspective. And, in about 10 states, including California, you still have to pay your state taxes.

The other way to think about Opportunity Zones is the benefit it provides to state and local budgets. Your alternative economic development strategies typically revolve around mortgaging the tax base, providing major tax abatements to companies moving into your state or city.

This program does exactly the opposite. Its incentives are built around creating growth businesses, new real estate development, and infrastructure projects. These are businesses that are going to build your tax base through property and sales taxes. And they are going to provided much-needed jobs and housing. So, I expect this will be a net tax gain for almost all states and localities.

Michael Moran: What are the risks you see in the space, both to your business and to the Opportunity Zones themselves? For instance, do you worry that the Blackstones and KKRs of the world are going to steal your IP by doing a few projects with you and then setting up their own in-house unit?

Glickman: No, not really, I think it would be great if Blackstone, KKR, and some of the larger private equity firms or hedge funds got into the game because I want to see as much capital flow into this program as possible. The reality is that for some of the largest institutional players, they don’t have a lot of trouble raising capital. On top of that, Opportunity Zones require raising capital from high-net-worth investors, family offices, and other tax-sensitive investors. Typically, those bigger firms have a large percentage of their investment come through tax-exempt sources like pension funds and endowments. So, while I expect some of the partners of those firms to be interested in participating in this program, I’d be surprised if this was a very important part of Blackstone’s or KKR’s businesses.

But let me say this: This is an inherently riskier asset class, which is why the federal government is subsidizing it. The fact is that these are geographies that have weaker economies. The risk level can be very different geography-to-geography and project-by-project. There are some geographies that are just overlooked because investors tend to have a herd mentality.

I actually put together rankings of every Opportunity Zone in the country based on its baseline economics called the Opportunities Zone Index, which also ranks cities, states and counties. One of the interesting things you’ll see as you explore the map is that many former industrial cities in the country that have had struggling economies have a cluster of really attractive zones that compete with any others across the country. You will find there are downtown zones which really have been starved for investment or housing or construction or businesses for decades, but have really attractive, undervalued assets. So, I do think you’ll start to see the tide turn on where investors look to place capital.