Puerto Rico could lose out on investors looking to funnel money into real estate projects on the island, if a bill to lock in the new incentive goes nowhere.
The increasing interest in the hurricane-ravaged island, virtually all of which is an opportunity zone, is putting pressure on the local government to pass a months-old opportunity zones tax bill that would give the island access to the same benefit as the break created in the U.S. tax overhaul. Much of the island needs rebuilding, making it particularly appealing to real estate investors.
But the bill’s passage remains uncertain months after it was introduced.
“I know of several investors on the line of deciding whether to invest in Puerto Rico or another zone pending the local legislation. But as time passes they are presented with opportunities in other areas and may have to elect those over Puerto Rico,” said Giovanni Mendez, a tax attorney at GEO Puerto Rico Services in San Juan. Mendez manages a $25 million opportunity fund and advises U.S. and Puerto Rico clients with opportunity funds ranging from $80 million to $250 million.
The 2017 tax law grants a two-part incentive to investors who move capital gains into qualified opportunity funds: a tax deferral on the gains moved into the funds, and a tax break on gains earned by funds held for longer than 10 years. But under current Puerto Rico law, investors have to pay a local capital gains tax, which could dilute the incentive’s benefits and shift attention away from the island.
Further complicating matters is the lack of final guidance from the Internal Revenue Service. The agency released proposed rules on the tax break (REG-115420-18) on Oct. 19, and another set is expected this year.
The tax perk is aimed at attracting investment into economically distressed areas. Interest in Puerto Rico has steadily increased amid fevered interest in cities like Chicago, Miami, New York, and Oakland, Calif.
In the meantime, the Puerto Rican government is pitching itself as an unparalleled investment destination.
“We’re very aggressively showing Puerto Rico as a place of businesses,” said Manuel A. Laboy Rivera, secretary of the Department of Economic Development and Commerce of Puerto Rico and executive director of the Puerto Rico Industrial Development Company.
The clock is ticking for investors to move eligible capital gains into opportunity funds. In order for capital gains to qualify for the tax break, they must be moved into qualified opportunity funds within 180 days of being realized.
Every day there are capital gains that are expiring out of the six-month window, making it imperative for local and federal authorities to issue final guidelines quickly, Mendez said.
The bill pending before the Puerto Rico legislative assembly is necessary because Puerto Rico is considered a foreign jurisdiction for U.S. tax purposes, despite being a U.S. territory.
The bill guarantees that U.S. residents investing in opportunity zones are exempt from Puerto Rico’s local capital gains tax at the time their investment is exited. The current capital gains tax rate is 15 percent.
If the local rules in Puerto Rico aren’t the “mirror image of the rules in the States, people are not going to invest in Puerto Rico,” said Richard Santana, managing partner of Colectivo 360, a real estate and business consulting group that is currently advising opportunity funds of between $25 million and $1 billion.
Looking for Certainty
The bill would also guarantee exemptions on building projects, tax-free dividend distributions, and expedited permitting for special projects that satisfy a panel—an additional hurdle that has some investors concerned about long wait times.
There is no set criteria for how the panel will approve projects, practitioners said, meaning that any investor hoping to meet the requirements will be playing a “guessing game.”
“The panel has raised some concerns, in particular, how the timing of applications could affect the reinvestment requirements,” Mendez said.
Practitioners say they have seen investors willing to move capital into Puerto Rico without the additional incentives offered in the bill. But nonetheless, passage of the bill would bring welcome certainty.
“Generally when there is a piece of legislation as significant as this one and with so many implications and ramifications, it takes time for the market to first digest and then to implement their investment strategy,” said Denisse Flores, a partner at PwC, also known as PricewaterhouseCoopers LLP, in San Juan.