President Joe Biden’s plan to raise the capital gains tax rate could make one of the most generous breaks enacted by Donald Trump even more lucrative—if investors can stomach the uncertainty.
The prospect of boosting the rate on capital gains to 39.6% for those making more than $1 million, as well as other changes, is setting off a scramble by the wealthy to figure out how to keep their tax obligations in check. That could lead some to a controversial perk for investing in the nation’s roughly 8,700 “opportunity zones.”
By developing real estate or funding businesses in these low-income areas, investors can avoid capital gains taxes after a decade—a benefit that would potentially become more potent with a higher rate.
Plenty of questions remain about whether Biden’s proposals will make it into law or whether he may seek to reform the opportunity zone incentives themselves. That’s had a chilling effect on efforts to raise money for funds trying to use the perks.
The Biden proposal “makes opportunity zones somewhat less attractive this year,” said Korb Maxwell, an attorney at the firm Polsinelli in Kansas City. “But, if they pass something and rates go up, it becomes more attractive in the future.”
Stoking Uncertainty
Opportunity zones were among the most innovative and bipartisan features of President Donald Trump’s 2017 tax overhaul. Investors can claim the incentives by selling an asset that’s appreciated in value and plowing proceeds into real estate or businesses in designated zones. That lets them defer taxes on capital gains through 2026. If the new asset is held at least a decade, it’s not subject to any capital gains tax when sold.
The goal was to encourage the wealthy to funnel money into areas desperate for economic development, but critics have said the rules are too loose and may do little to help the poor. Economists at the University of California, Berkeley recently showed that investors have gravitated toward zones that were already on the upswing.
Biden suggested while campaigning that he would look to reform the breaks to ensure they provide a social benefit. But his administration has said little about its plans. Lawmakers have proposed a variety of changes to boost transparency and limit some kinds of investment in the zones.
The potential for a higher capital gains rate has some investors wondering if they would be better off paying taxes on gains now than potentially taking a bigger hit if they defer them until 2026.
Requesting $1
Erik Hayden, the managing partner of Urban Catalyst, a opportunity zone fund developing several buildings in San Jose, California, said every investor he’s talked with is asking about what might happen.
One recently wanted to reduce an investment in Hayden’s fund by $1 so that it fell just under the $1 million cutoff Biden has proposed for the higher rate. Hayden had to explain why that wouldn’t necessarily get the investor out of paying.
“In the long-term the OZ program will be fine, if not a little stronger,” he said. But, “in the run-up and the confusion about whether it’s going to pass, there’s going to be a lot of folks who’d say, ‘I’d rather just pay my taxes.’”
Other changes Biden is proposing—such as new limits on a popular break used by property investors—could drive more money to opportunity zone funds, said Michael Williamson, chair of the real estate practice group at law firm Buchalter in Los Angeles. But he worries that Democrats might also target the incentives themselves, making them more complex or unattractive.
“There’s still the uncertainty around what changes will happen to the opportunity zone program,” Williamson said. “At the end of the day, the opportunity zone program makes a good deal great, but doesn’t make a bad deal good.”
—With assistance from Lydia O'Neal.
This article was provided by Bloomberg News.
