Opportunity zone tax breaks aren’t drawing in non-U.S. investors thus far, but the IRS is working on regulatory changes that some think could increase interest among foreign investors.
The incentives, established in the 2017 tax law, allow investors to defer and reduce their capital gains taxes by plugging profits from stocks, bonds, real estate, and other assets into funds that finance projects in designated zones. But, since foreign individuals are generally only subject to U.S. tax on a narrow set of capital gains, their chances for taking advantage of the opportunity zone incentives are few and far between.
“We’ve kicked it around with some of our foreign investor connections and clients here and there as something that’s available,” said Katie Roskam, a partner at Varnum LLP in Grand Rapids, Mich. “But it hasn’t been, in my experience, something that’s been pursued with any sort of passion by any of the foreign clients we’ve worked with.”
That could change depending how the IRS handles upcoming rule revisions. The agency is working on a proposal (RIN: 1545-BP50) to change the rules governing eligibility requirements for foreign investors interested in deferring their capital gains by putting their money in opportunity zones. The proposed rules could come out by December, according to the White House Office of Management and Budget’s most recent regulatory agenda.
Foreign investors are currently allowed to participate in opportunity zones through U.S. corporations—often called blocker corporations—that have capital gains to invest, or as partners in a partnership with capital gains, as long as the partnership isn’t formed just to help foreign investors skirt the rules.
Foreign individuals are subject to withholding on gains “effectively connected” to a U.S. business and, under a 1980 law (Public Law 96-499), gains from U.S. real estate.
IRS final rules released late last year (T.D. 9889) said those with “effectively connected” gains “may generally” take advantage of the tax deferral. Under that 1980 law, however, the agency said it won’t allow foreign investors to avoid withholding by investing in opportunity zones, effectively nullifying the capital gains deferral for those individuals.
But officials left the door open, writing in the rules that they would “continue to consider” how this withholding regime might work for opportunity fund investments.
The IRS didn’t respond to a request for comment, but tax and finance professionals said the fact that the IRS has largely issued taxpayer-friendly guidance for the incentives thus far is a promising sign.
There is no reason why the rules can’t open the incentives up to foreign investors, as there is nothing in the law preventing the IRS and Treasury from doing so, said Harold Adrion, a New York-based consultant at EisnerAmper specializing in international tax.
Drawing Some Money
It is unclear how much foreign investor involvement in opportunity zones would increase if the rules were changed to allow them to delay tax withholding on their real estate gains until 2026.
Some lawmakers are interested in providing an additional incentive for foreign investors to look at opportunity zones: Sen. Mike Rounds (R-S.D.) last year introduced a bill (S. 2778) that make changes to the EB-5 visa program, which is available to investors in new commercial enterprises.
That bill, co-sponsored by Senate Judiciary Chairman Lindsey Graham (R-S.C.), Sen. John Cornyn (R-Tex.), and Senate Minority Leader Chuck Schumer (D-N.Y.), would allow high-net worth individuals to get permanent residence in the U.S. in exchange for investing in opportunity zones, if they meet other program requirements.
Tax professionals say that at least some foreign money is flowing into opportunity zones under current rules.
Reid Thomas, managing director of NES Financial, said some foreign investors have chosen to invest in opportunity zones without using the tax benefits. Those decisions were based on the expectation that more capital will flow to those areas, their bets hedged by the prospect of government-subsidized economic growth in the neighborhoods where the projects are located.
Daniel Ryan, a partner at Sullivan & Worcester in Boston, said he has seen some foreign investors putting money into projects alongside opportunity funds, but hadn’t seen any interest among them in actually using the capital gains tax breaks.
“Really, in my experience, it’s been US investors almost entirely"” Ryan said. Still, he added, “I think it would make foreign investors more comfortable if they had clarification about withholding and who’s responsible for that.”