For all the debate about the Trump 2017 Tax Reform, the creation of the Opportunity Zone Program could be an engine for economic development in low income communities. The goal of the program is to encourage investment of deferred capital gains into pooled funds which would then be invested in state designated, federally approved Opportunity Zones. Last week, Florida Senator Marco Rubio and South Carolina Senator Tim Scott (both Republicans) were in Miami to promote Governor Rick Scott’s newly designated Opportunity Zones. On their tour, Senators Rubio and Scott did a good job of preaching the potential benefits of the Opportunity Zones and what the investments could bring. But they did not explain the long process it will take to bring the dollars to the community or any potential pitfalls.

The program works similar to 1031 tax free exchanges. Taxpayers can defer long term capital gains if the capital gain portion of a sale is reinvested in a Qualified Opportunity Fund (a 1031 exchange requires that ALL net sales proceeds, gain and principal, be reinvested in a replacement property). A Qualified Opportunity Fund is an investment vehicle that is organized as a partnership or corporation for the purpose of investing in an Opportunity Zone. A designated Opportunity Zone is a census tract with a poverty rate of 20 percent or a median family income lower than 80% of the area average.

State governors were to nominate up to 25% of the eligible low income tracts as Opportunity Zones by March 21, 2018. Florida received an extension until April 20, 2018 and on April 20, Governor Scott nominated 427 areas, 25% of those eligible, for designation. The Treasury Department has 30 days to make the designation and when it does, the designation will be for 10 years.

The benefit to the taxpayer is a step up in basis. If the investment is for 5 years, the step up is 10%. If the investment is another 2 years, the taxpayer receives another 5% step up. On December 31, 2026, the tax payer will recognize the remaining deferred gain.

As Opportunity Zones are created and funded and investors create projects in Opportunity Zones, development should jump start in these low income areas – perhaps more quickly then would have occurred without this program. At least that is how Senators Rubio and Scott spun the program. And, it is a good thing any time dollars are targeted for development, particularly in low income neighborhoods. Obviously, for those of use in the real estate industry, more capital should mean more activity for all of us.

However, private dollars as well as state and local dollars are often already targeted in these same areas. In some cases, these efforts have had some success. In others, the successes are hard to find. Pumping money into any area, private or government, doesn’t work unless there is a plan. The local government has to be willing, and able, to work with developers to approve projects through its zoning code and permitting process. There has to be a vision and a master plan in place and the local governments must offer incentives to start up and small businesses to assure that there are essential non-governmental services (and governmental services) for the residents that are targeted with the new development. Otherwise, the government dollars will be wasted, or worse, go unfunded.

Opportunity Zones could truly spur meaningful growth and development. Or, they could be another case of putting the cart before the horse.

President Trump finally announced his Tax Reform Plan on November 2. The reduction of corporate tax rates and the lowering of individual tax brackets for high income earners has received the most attention from the media.  But those of us in real estate were anxious to see if the president and Speaker Paul Ryan would follow through on all of their promises to change some sacred cow real estate provisions of the Tax Code.

Not long after President Trump took office, I wrote of some of the potential changes that many experts expected would be included in the Trump plan (see post HERE) regarding real estate. The experts weren’t far off.  I don’t want to discuss the entire tax reform plan, only those provisions dealing with real estate.  The most obvious provision is the mortgage interest deduction.  From the beginning, President Trump said that he would not eliminate this popular deduction.  Instead of eliminating the deduction, the Trump plan preserves the deduction, but it reduces the cap for married couples for mortgages worth $1,000,000 to $500,000.  This reduction would apply to new mortgages only.  Existing mortgages would be exempt.  I suppose the intent was to allow homeowners to keep a tax break that they had when they bought a new home but the effect is that the cap reduction will be a disincentive to home buyers, particularly in areas where home costs are high.

The mortgage interest deduction will not apply to second or vacation homes. Many will argue that this eliminates a tax break on the wealthy.  But the elimination of this deduction has potential to greatly affect the real estate market.  It will put numerous people out of the second home market completely which will depress property values in many places.  Second-home communities (think beach towns and mountain communities) will suffer economically with out the seasonal influx of second home/vacation home owners.

The Trump plan makes it more difficult for homeowners to get the capital gains exemption on their primary residence. Existing law allows you to exempt up to $250,000 of capital gains ($500,000 for married couples filing jointly) if you have lived in your primary residence for 2 of the past 5 years.  The Trump plan will lengthen the time requirement to 5 out of the previous 8 years.  This will provide many homeowners another disincentive from moving further depressing the re-sale market.

The proposed Trump plan retains the deduction for state and local property taxes up to $10,000 but eliminates the deduction for state and local sales and income taxes. Not only will residents of high tax states be hurt by the elimination of the latter deduction, so will owners of income producing property all over the country.

The Trump plan eliminates the deduction for moving expenses. This deduction only applies if you are required to move for a new job or a transfer for an existing job.  While the elimination of this deduction is unlikely to affect most peoples’ decision whether to sell their home and move, it does make the cost of a move more costly and could affect a buyer’s decision on how much to spend on the new purchase, or whether to purchase at all.

The Low Income Housing Tax Credit has been retained under the new plan. Unfortunately, other changes in the Trump plan effectively gut the LIHTC.  Nearly half the new low income housing development is done with private activity bonds.  These tax exempt municipal bonds are scrapped under the Trump plan.  The other half of low income housing development is financed on the tax credit program.  They will become more expensive as tax rates go down because tax credits will worth less.  Some experts predict that over 80,000 fewer new affordable housing units will be constructed next year if the Trump plan is passed.

The president made no changes to 1031 exchanges or in changing the rules regarding deductability of capital expenditures which many experts had predicted would be part of tax reform. However, as the real estate president, maybe we should not be surprised as Mr. Trump has used both provisions in his years as a real estate entrepreneur.

The real estate president has made some surprising tax reform proposals that could have some very adverse affect to the housing market. If passed, housing prices could fall significantly while not immediately attracting new buyers.

There will be a long battle in Congress over tax reform. Despite President Trump’s and Speaker Ryan’s desire to pass the legislation before the end of the year, we are likely to see lengthy debate and multiple amendments.  Already, the Senate has announced its own plan which keeps the mortgage interest deduction and the deduction for state and local income taxes.  It is not only unlikely that tax reform will achieve bi-partisan support, but it is obvious that it dos not have full Republican support.  So, as changes are made, it will be interesting for us to see how the provisions pertaining to real estate continue to evolve.

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    Welcome to Assouline & Berlowe’s Florida Real Estate Law and Investment Blog with news, insights, and commentary for investors, developers, and their advisors.


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