How do Opportunity Zones Work?

The 2017 Tax Cuts and Jobs Act created the Opportunity Zones program—meant to spur investment in undercapitalized communities.

The program provided three tax benefits for investing unrealized capital gains in Opportunity Zones:

• Temporary deferral of taxes on previously earned capital gains. Investors can place existing assets with accumulated capital gains into Opportunity Funds. Those existing capital gains are not taxed until the end of 2026 or when the asset is disposed of.
• Basis step-up of previously earned capital gains invested. For capital gains placed in Opportunity Funds for at least 5 years, investors’ basis on the original investment increases by 10 percent. If invested for at least 7 years, investors’ basis on the original investment increases by 15 percent.
• Permanent exclusion of taxable income on new gains. For investments held for at least 10 years, investors pay no taxes on any capital gains produced through their investment in Opportunity Funds (the investment vehicle that invests in Opportunity Zones).

Investors can take advantage of one or more of the benefits. To access the second benefit, investors need to have reached the 5 or 7 year mark by 2026, meaning that new projects can no longer receive the basis step-up tax benefit. But the 10 year hold period can happen after 2026, meaning investors can make use of the permanent exclusion tax benefit for new projects.

What Types of Projects are Being Financed?

Opportunity Zone tax incentives can be used for commercial and industrial real estate, housing, infrastructure, and existing or start-up business investments. For real estate projects to qualify for the tax incentives, the investment must result in the properties being “substantially improved.”

Opportunity Zone eligibility requirements are minimal compared with other federal community development tools. For example, there are no requirements (as with the Low-Income Housing Tax Credit) that new apartments be rented to low-income residents; no requirements (as with the Small Business Administration’s 7(a) and 504 loan guarantee programs) that federally backed investment occur only when fully private-market financing is unavailable; and no requirements (as with the New Markets Tax Credit) that investors establish an oversight board of community development experts and representatives to review projects. Some “sin” businesses are, however, excluded outright.

Our qualitative analysis of early year Opportunity Zone investments found that the vast majority of capital flowed into real estate rather than operating businesses. Both the Joint Committee on Taxation and Office of Tax Analysis  show that roughly two-thirds of investee businesses were in the real estate, construction, or lodging industries. But this finding likely underreports real estate investment, as occupants of investment properties could span a number of industries. According to an Opportunity Zone accounting firm, less than 3 percent of equity raised went into operating businesses. 

In general, Opportunity Zone projects provide market-rate rental housing, as well as commercial and industrial real estate. One analysis of investment into Colorado found roughly three-fourths of projects were multifamily housing.

Who are Investors in the Program?

Any corporation or individual with capital gains can qualify to make Opportunity Zones investments. Eligible capital must be provided as an equity investment, not debt (though debt could be part of a larger financing package), and investments must result from a taxpayer’s recently realized capital gains.

And who are investors in the program? Insights are limited, but we do know that investors for Opportunity Zone projects are typically exceptionally high income with an average annual income of $4.9 million, which is in the 99th percentile. Per capita, the highest share of investors came from wealthy or growing states including California, New York, New Jersey, Connecticut, Nevada, Utah, and Colorado.

Where Have Opportunity Zone Investments Gone?

Roughly 12 percent of US census tracts, 8,764 census tracts across all 50 states, Washington, DC, Puerto Rico, and four US territories are Opportunity Zones. Governors nominated Zones from among eligible tracts in 2018, with the US Treasury responsible for reviewing and making final approvals.

Being designated a zone does not guarantee investment. We have some preliminary insights into investment patterns. Nearly half of designated zones (48 percent) received some investment between 2018 and 2020. As a paper emerging from the Joint Committee on Taxation identifies, this investment hasn’t been geographically widespread. Just 1 percent of zones received 42 percent of investment, and fully 78 percent of investments went to just 5 percent of zones. And, as the statute allows, $1 in $10 of investment actually happens outside of zones, including higher-income communities. Generally, Opportunity Zones benefit a “narrow subset of tracts in which economic conditions were already improving prior to implementation of the tax subsidy,” as per the Joint Committee on Taxation report.

When weighting tracts by the size of Opportunity Zone investment, the Office of Tax Analysis found that zones with investment had more residents with a bachelor’s degree (29 versus 15 percent), higher median home values ($242,000 versus $136,000), higher median incomes ($43,000 versus $36,000), lower unemployment (9 percent versus 12 percent), and lower poverty rates. Looking at race and ethnicity, zones receiving investment had a lower share of Black residents, a higher share of Latinx residents, and a nearly identical share of white residents than those that did not receive investment.

Additionally, Opportunity Zones have a considerable urban bias. As of 2020, 95 percent of investments were made in urban zones, more than the 86 percent of zones in urban areas. The states with the highest share of zones receiving investment include DC, Oregon, Colorado, Utah, and Arizona, while Kansas, New Mexico, Alabama, Iowa, and Illinois had the fewest share of zones receiving investment.

These findings add to another debate that’s been taking place since the program was first launched—whether zones were showing signs of gentrification before the program started. Our research found that a small share of zones, roughly 4 percent, experienced a sizable degree of socioeconomic change between 2000 and 2016. Given the concentrations in Opportunity Zone investing, it’s possible that relatively few zones are gentrifying and also that much or most of the investment is going to these communities.

What are the Effects of Opportunity Zones on Communities?

Initial impact studies of Opportunity Zones designations show mixed, limited, or no effects of the incentive on designated neighborhoods. Importantly, these are estimates of the impact of a census tract being designated as a zone, not of receiving investment, as data on the exact location of investments aren’t publicly available. (In research-speak, this means they are akin to “intent to treat,” not “treatment on the treated” analyses.)

One paper found zone designation was not linked to increased job postings in aggregate, but postings did increase in certain urban neighborhoods. Another paper found designated tracts had no greater degree of new business formation, new business loans, commercial diversity, or consumer spending than non-designated tracts, nor did designation lead to more venture capital investment. Conversely, another study found designation increased employment between 2017 and 2019 by 2 to 4 percentage points. When looking at residents rather than jobs in a neighborhood, another study found zone designation had no statistically significant effects (PDF) on employment, earnings, or poverty rates.

Analysis of real estate trends within zones also showed mixed or no effects. Although one study found that commercial property and vacant land prices increased, another showed that designation had no significant effect for commercial investment. One study found that residential real estate prices increased in zones, but there was no statistically significant effect on transaction volume. Another paper found that single-family home prices did not significantly increase in price within zones. A different study found zone designation had no effect on home or small business lending.

Updated January 2024