The Tax Cuts and Jobs Act of 2017 was signed into law December of that year, creating a new benefit for investors. Called Opportunity Zones, the initiative’s purpose is to steer investment into areas that struggle with attracting development by allowing capital gains to be redirected into qualified projects, earning investors federal tax advantages. The program is being overhauled, opening the door for places such as Pinal County to take greater advantage of this economic development tool.
“It was about 4:30 p.m. on the Friday before Christmas when the Tax Cuts and Jobs Act passed,” recalls Shawn Neidorf, chief opportunity and research officer for the Arizona Commerce Authority (ACA). “Our CEO Sandra Watson came over to the research team and said, ‘Oh good, you’re all still here,’ which isn’t what you want to hear on the last day before going into a holiday. But the bill had created Opportunity Zones, and we were asked to figure out what they were and where they could go in the state.”
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Neidorf and her colleagues began to reach out to cities, counties and tribes across the state to hear their thoughts on where Opportunity Zones should be placed. After receiving feedback from local partners, the ACA sent a list of recommendations to then-Gov. Doug Ducey. Once the process was finished, Arizona designated 168 Opportunity Zones, which brought more than $2.65 billion in investment to the state.
“The idea here was to get people who are passively holding investments to sell them and reinvest them in places they might otherwise very much overlook,” Neidorf explains. “It’s about supporting communities that have struggled growing in the 21st century.”
How Opportunity Zones work
As with most government incentives, the particulars of Opportunity Zones can be esoteric to outside observers, but Neidorf says the whole process starts with census tracts. These subdivisions typically have anywhere from 1,200 to 8,000 people within them and function as an administrative unit for the U.S. Census Bureau. The agency uses them for a variety of purposes, including building congressional districts.
“Census tracts don’t cross state or county lines, but they wash right over municipal and tribal boundaries,” Neidorf explains. “They generally follow identifiable features. In urban areas, that’s generally roads, but in rural areas, it could be a mountain range, wash or a river. But [the Census Bureau] is looking for clusters of people who naturally live together.”
Because of those restrictions, census tracts tend to be small squares or rectangles in denser regions and large, irregular shapes in rural areas. Regardless of the size, a census tract can only become an Opportunity Zone if it meets the statutory criteria — having a low median family income or a high poverty rate.
“To qualify as an Opportunity Zone in the [first version of the program], a tract needed a median family income of no more than 80% of the state’s median household income, or 80% of the nearby metro area if in a denser region,” Neidorf says. “The other way to qualify was having a poverty rate of 20% or more, even if the tract had a higher family income. But the standards are much more strict now.”
In the updated version of the program, only 125 eligible census tracts can be nominated by Gov. Hobbs for an Opportunity Zone designation by the U.S. Department of Treasury, so competition is fierce. Neidorf offers community leaders the following best practices:
- “Opportunity Zones make a promising deal even better for investors, but it can’t make a losing proposition worth it. It’s a tool to attract investment, not a grant program.”
- “Investors want to deploy capital quickly, so tracts that have power, water, sewer and zoning and entitlements are what they’re looking for.”
- “If a tract is too remote, it’s difficult to build housing, retail or industrial projects because it won’t have the customers, workers and residents it needs.”
Opportunity Zones 2.0
The latest iteration of Opportunity Zones offers regions across Arizona another chance to bring a powerful economic engine into their communities, but with a catch — the median family income target dropped to 70%, and a ceiling of 125% was put in place.
“The 20% poverty rate option remains, but tracts are now income capped. That means an area can’t be well off besides a little pocket of poverty,” Neidorf explains. “The goal is for Opportunity Zones to go to much more distressed communities this time.”
To that end, a new mechanism was created to encourage development in rural areas. Investors who put money in funds focused on rural Opportunity Zones receive an additional incentive.
“Say you sold a business and got $10 million in capital gains. If you put that into an Opportunity Zone fund, you would put off paying taxes on the sale for five years, then would only be taxed on $9 million,” Neidorf says. “In a rural Opportunity Zone, the exclusion grows to 30%, meaning only $7 million is taxed.”
When the program was originally established, the state had 1,526 census tracts, 44% of which qualified as Opportunity Zones under the original criteria. Arizona’s recent population growth, however, is reflected in additional tracts being drawn, bringing the new total to 1,756. With the new rules in place, only 28.5% qualify.
“There’s a smaller number of eligible tracts today than in 2018, despite there being 200 more of them,” Neidorf concludes. “We simply have fewer places in economic distress — which is what we’ve all been working for.”
