Opportunity Zones Create New Opportunity for Smart Cities
A new tax incentive could help stakeholders build smart cities from the ground up
With the hope of spurring private investment in low-income areas, Congress is dangling one of the biggest tax incentives to ever occur in U.S. economic development: Opportunity Zones.
These zones are creating an unprecedented opportunity for the public and private sectors to work together to create smart cities from the ground up, lifting blighted areas and perfecting scalable technologies that can be rolled out to developing American economies nationwide.
What are Opportunity Zones?
Tucked inside the Tax Cuts and Jobs Act (TCJA) of 2017, an initially little-noticed program called the Investing in Opportunity Act aims to revitalize some of the nation’s most economically distressed communities using private investments instead of taxpayer dollars. Most of the attention has focused on the benefits for housing developments and new businesses, but the program also sets the stage for investing in infrastructure and technology.
In a nutshell, Opportunity Zones are census tracts generally comprised of low-income neighborhoods that qualify for the program based on criteria laid out in the TCJA. Governors of U.S. states and territories—as well as the mayor of Washington, D.C.—had until April 2018 to nominate qualifying census tracts in their jurisdictions.
To date, more than 8,700 Qualified Opportunity Zones have been designated in all 50 states, the District of Columbia, and five U.S. territories. For instance, all of Puerto Rico qualifies as an Opportunity Zone. Once certified, areas retain their designation for 10 years.
What’s the incentive for private investors?
A major tax advantage awaits investors who support Opportunity Zones. American investors maintain an estimated $6.1 trillion in unrealized capital gains. By investing some of those gains into qualified Opportunity Zones, they can enjoy capital gains tax incentives exclusively available through the program that apply immediately, and in the long-term.
Here’s how it works: Normally, diverting an appreciated asset such as stocks or real estate is a taxable event. But if the investor reinvests that capital gain within 180 days into an Opportunity Zone, they can defer their tax liability until 2027. They can also potentially receive tax-free treatment for all future appreciation earned through the fund.
Smaller tax incentives exist for investors who sell their Opportunity Zone investment after five or seven years, but the overarching goal is drawing patient capital from the $6.1 trillion of unrealized capital gains—to be invested in distressed communities for the long-term. Read this carefully: capital gains tax is permanently eliminated for appreciated investments kept in Opportunity Zones for at least a decade.
Opportunity Zones, this new tax incentive, is paving the way for one of the largest economic development initiatives in U.S. history.
To access these benefits, people must invest in Opportunity Zones through qualified Opportunity Funds, defined as a U.S. partnership or corporation that intends to invest at least 90 percent of its holdings in Opportunity Zones. These funds are governed by Internal Revenue Code (IRC) section 1400Z-2 and must adhere to program guidelines to reap the tax rewards. That includes restricting investments to qualified Opportunity Zone property that includes:
Partnership interests in businesses operating in an Opportunity Zone
Stock ownership in businesses that conduct all or most operations within Opportunity Zones
Property such as equipment or real estate located within an Opportunity Zone
So, why is that different than existing economic development programs?
Other programs exist that encourage private investment in low-income areas through tax advantages, such as the New Markets Tax Credit and Low-Income Housing Tax Credit programs. But the Opportunity Zone program stands out as less restrictive, less costly, and less reliant upon government agencies to function.
A limited number of tax credits can be issued each year through the other programs, which caps the number of investors who can participate—and by extension, the amount of money that’s invested. Since Opportunity Zones are governed by a new IRS rule instead of a traditional tax credit program, there's no limit on the number of Opportunity Funds that can exist.
Opportunity Funds are also self-certified, meaning they are managed entirely in the private market. Fund managers are solely responsible for administrating these funds, not government agencies or investors.
Finally, there’s no cap on the amount of capital that can be invested into Opportunity Zones through the program. That means there’s also no limit to the extent that the program can help transform blighted areas.
What does all this have to do with smart cities?
By 2050, 75 percent of the world’s population is projected to strain urban centers—and city leaders have long understood that using data and digital technology holds the key to building more efficient and livable urban environments. Information collected by these smart technologies also helps city leaders efficiently manage assets and resources as populations grow exponentially.
Smart city technology spending is expected to reach $135 billion within two years as cities implement digital transformations to improve environmental, financial, and social aspects of urban life.
Given the significant interest among investors in Opportunity Zones, it’s possible that this new tax incentive could connect billions of dollars in private capital to projects in low-income communities, paving the way for one of the largest economic development initiatives in U.S. history. The pooled fund model is also expected to increase the scale of investments while reducing the risk to individual investors.
This large investing opportunity offers the potential for city planners to access the long-term funding they need to truly transform an area into a smart city. And some lower-income areas are great candidates for smart city planning, presenting a virtually blank canvass for digital innovations.
Building a digital infrastructure from scratch is can be simpler and more cost-efficient than retrofitting an existing urban fabric. The challenges of integration sometimes force developers to either patch initiatives together with legacy equipment or replace wasted investments into technology that don’t fit the new direction.
In contrast, the ability to design smart city infrastructure from the ground up in Opportunity Zones—exactly the way they want it—gives city planners a unique opportunity to test new technologies and perfect smart city designs. Once they are running smoothly, the zones can serve as ground zero for an expansion of a smart city design that promises a high quality of life to the people who live, work, and visit.
Adding strong technology infrastructure to blighted areas is also likely to drive additional outside investment by making the Opportunity Zone more enticing to other developers. Although the program’s tax incentives themselves are a strong enticement, the practical side of finding projects that can deliver acceptable returns in economically depressed areas is still important to sealing additional investment deals.
For instance, the city of Erie, Penn., aims to bring video surveillance security cameras, energy-efficient LED lighting and free public Wi-Fi to neighborhoods targeted for reinvestment as Opportunity Zones. City officials say the city can improve safety and save up to $500,000 a year on electrical costs by the widespread implementation of LED lighting.
Cameras that can read license plates and have facial recognition capabilities provide information on traffic flow and contribute to public safety by helping Erie police identify perpetrators in high-crime areas. And free public Wi-Fi in public parks and similar spaces will not only benefit the people who live and work in those areas but make the zones more enticing for redevelopment.
“When you put this kind of investment in those areas, you’re well-aligned for the other investment that will follow,” explained Karl Sanchack, CEO of the Erie Innovation District. “As we improve digital infrastructure, and as others improve the urban land use in those areas, each of those things complements the other. And you’re getting more value for the money that’s invested.”
The intersection of public-private partnerships, smart city tech, and Opportunity Zones
The significant tax advantages offered by the Opportunity Zones program can also make it easier for cities to check off important projects on their smart city wish lists by forging public-private partnerships (PPPs). Governments often collaborate with private sector companies through PPPs to fund, build, or operate projects they can’t manage on their own. In exchange for its contribution, the private company usually receives a portion of the project’s profits. Many smart city initiatives are built on a PPP foundation.
Putting together an investment deal in an economically challenged area can be an easier sell to private companies when they know they have support from the public sector. The public sector can ease and, in many cases, subsidize the cost of basic infrastructure that’s needed for smart city growth, such as transit, public safety, and roads. The opportunity zone tax advantages also enhance the return on capital, making it easier for private investors to accept initially lower returns in less desirable areas until the future potential of the Opportunity Zones are realized.
Unlocking the future potential of Opportunity Zones
As urban populations explode, technology has the power to keep cities sustainable for the long-term. Opportunity Zones offer city leaders a unique chance to build an ideal smart city development from the ground up, creating a platform for testing new ideas while implementing positive change in an economically distressed neighborhood.
Sergio is a 20-year expert on innovative public-private multi-stakeholder governance models, from shaping social impact initiatives, regulatory frameworks to smart city policy & programs. Chairman & Founder of P3 Smart City Partners, a smart city & digital infrastructure, public-private partnership government advisory and investment company sparking positive social, environmental, and economic vitality in the urban landscape. Chairman & Founder, PVBLIC Foundation, an organization focused on using media, technology & data to drive impact & change. Board of Smart Cities NY, Atlanta Smart Cities, United Nations Economic Commission for Europe, Business Advisory Board Expert, Rutgers University Big Data Advisory Board, Co-Founder & Executive Vice-Chair of the Blockchain Commission for Sustainable Development, and Vice-Chair of the New York Global Leaders Dialogue (NYGLD). @sfdecordova @p3smartcity @blockchainsdg.