Startups moving to designated opportunity zones — drawn by low rents and the promise of investors — are doing what the legislation intended.
The purpose of the OZ legislation was to create jobs and prosperity in neighborhoods that had not experienced the same growth as more affluent areas. The program allows for investment in opportunity zone funds to defer and reduce existing capital gains tax as well as realize future capital gains without any tax liability.
Since the IRS began providing detailed guidance on opportunity zone legislation in April 2019, a reported $3.2 billion in capital has poured into opportunity zone funds, according to the Novogradac Opportunity Funds Listing, of which 87.2% is intended to invest in real estate. Only a mere 2.6% of funds that have been raised are intended to invest in operating businesses. These businesses, which hire new employees and support local businesses, stand a far better chance of achieving the designed benefits of the program than real estate development.
Why has all of the capital flowed to real estate as opposed to operating businesses? Because for many real estate developers, the program only serves to subsidize their cost of capital for projects that would have been developed regardless. Similar to other tax programs designed to spur development like the 421A program in New York, the winners are the developers and investors — not the end users and not the communities. The good news is that businesses are beginning to realize the benefits of operating in opportunity zones, making themselves more attractive to investors with the added bonus of lower rents.
Prior federal tax reforms have spawned massive new investment industries — — such as the 401(k) legislation that spurred the retirement investment market and the mortgage interest tax deduction that helped accelerate the housing market economy. The budding investment opportunity for OZ businesses stands to do something similar.
“Not only will these businesses create jobs and prosperity outside the major business districts of Manhattan, but current and future investors will participate in the unique capital gains tax benefits that come with opportunity zone businesses,” said Compound CEO Janine Yorio.
There are only a few opportunity zones in Manhattan, which are predominantly concentrated in Northern Manhattan, generally in neighborhoods that do not have great public transportation access. There are only five designated opportunity zones in Manhattan that are south of Central Park.
One such qualified opportunity zone business (“QOZ business”), Compound Asset Management, Inc., has opened its office in one of Manhattan’s few designated Opportunity Zones. Compound’s corporate headquarters is in a ground-floor commercial storefront in New York City’s Lower East Side, and is the first such company to relocate for this reason. By occupying what was once a vacant retail space, Compound employees and guests can fully participate in the evolving neighborhood on the street level. As a growing business, Compound plans to add at least 10 jobs there in the next 12 months.
“Due to the excessive retail vacancy rates throughout the city, we were able to negotiate a favorable lease on a brilliantly located retail storefront that gives us cheerful space and also a window on to the community,” says Janine Yorio.
When businesses open in a QOZ, they also bring new customers to existing businesses — employees buy coffee at the local shops, eat lunch at the local cafes and bring new activity and people to the OZ neighborhood — exactly what the legislation was intended to do.
Compound is notable in that it is led by real estate industry veterans Janine Yorio (previously head of real estate development at Standard Hotels) and Manish Shah, co-developer of the project at 148 Attorney Street, another OZ project also on the Lower East Side. Over their careers, they have witnessed neighborhood transformation — notably, the Standard Hotel on the Highline cemented the meatpacking district as the epicenter of cool and culture when it opened in 2009.
Compound’s move underscores its mission of transforming the real estate industry. Historically, real estate investment has been accessible only to those with enough wealth to afford it. With Compound’s technology, the company is shifting the narrative and the faces of real estate investors to better represent people from all walks of life, increasing diversity and inclusion by enabling people to invest in the cities in which they live.
Additionally, Compound is sponsoring the Opportunity Zone Business Database at ozbusiness.org as a platform for opportunity zone qualified businesses. Since the database was launched in mid-2019, 70+ businesses have self-identified as QOZ businesses in 23 states. The businesses themselves run the gamut from food & agriculture to finance & insurance.
The Opportunity Zone legislation is part of the Tax Cuts and Jobs Act of 2017 and was designed to spur long-term, patient private capital investment and job creation in eligible low-income areas. New York City has about 300 designated opportunity zones, including several in Manhattan. In April 2019, the IRS clarified that QOZ businesses are eligible for the same capital gains tax benefits they would receive on real estate investments in opportunity zones. In 2018, over 1,700 opportunity zone funds were announced and more than $26 billion was invested.
Investors who invest their capital gains* in a QOZ business are eligible for many tax benefits, including:
- Deferred tax on capital gains (from selling stock, real estate, art, cryptocurrency, etc.) until Dec 2026.
- Reduced taxes on the original capital gains by up to 15%.
- Elimination of any tax on all new capital gains if the investment is held for 10 years or more.
*After selling an appreciated asset (it could be stocks, bonds, business, real estate, cryptocurrency, yacht, art, etc.), an investor must invest the gains into an opportunity fund within 180 days of the sale, or if the gain is from an investment in an LLC or LLP, from the end of the tax year of the entity. Investors may then elect to defer their gains at the time of filing their year-end tax returns.
Compound intends to qualify under the safe harbors outlined in the most recent guidance provided by the IRS about opportunity zones.
About Compound Asset Management, Inc.
Compound (www.getcompound.com) is a fintech company based in New York City that is reimagining how the world invests in real estate, empowering investors from diverse backgrounds and geographies to own a piece of the cities they love. Compound is led by an executive team with deep real estate, brand, design, and finance experience. Compound’s platform enables millions of investors — who have historically not had access to the largest global asset class — to buy and sell shares of beautiful apartments in beautiful cities.
Janine Yorio, CEO