Why are PE and VC investors steering away from opportunity zones?

April 1, 2019

PE (private equity) and VC (venture capital) investors are steering away from opportunity zones.  Why? 

The Tax Cuts and Jobs Act of 2017 made the most significant form of tax reform in the past 30 years.  The bill reduced individual and corporate tax rates significantly, reducing the tax burden of the typical American family 20%.  It was an amazing feat of political achievement.

Within the new law is a not very well-known provision on “opportunity zones”. 

What are opportunity zones?  Opportunity zones are depressed economic areas – as defined by the federal government – where investors can invest their capital gains and avoid or defer capital gains tax. 

The exact provisions are detailed in the following table, provided by private equity data provider Pitchbook.  Essentially, an investor can defer their current capital gains for up to ten years by taking their current capital gains an investing that money in an opportunity zone fund.

An opportunity zone investment allows an investor to reduce their tax liability by 10 percent if held for five years and up to 15 percent if held by ten years or more. 

The tax benefits of an opportunity zone don’t stop there.  If you hold your additional gains from an opportunity zone investment in the fund for ten years or more, your gains in excess of the original investment become tax-exempt.  It’s such an incredible tax advantage that one might wonder why PE and VC investors would steer away from opportunity zones.  Can you guess why?

Source: Pitchbook, IRS

Why are PE and VC investors steering away from opportunity zones?

So, why would PE and VC investors be steering away from opportunity zones?  The answer lies in where the opportunity zone fund is generating income.  The income requirement states that over 50% of the opportunity zones’ business must be generated within the opportunity zone.  With technology and other early-stage companies looking for exponential growth, it’s likely that most of the companies’ revenue will come from outside of opportunity zones should the companies become success.  Thus, PE and VC investors don’t see much tax benefit in investing in opportunity zones.

Conclusion

Private equity and venture capital investors appear to be steering away from investing in opportunity zones.  Based upon the actions of investors and the current regulatory interpretations of the new law, it appears PE and VC investors are steering away from opportunity zones because of the income requirement.  Perhaps regulators will change their interpretation of the new law.  Until they do, it’s likely PE and VC investors will continue to shy away from opportunity zone funds for the foreseeable future. 

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