The Opportunity Zone (OZ) program in New York may be slowing down following state lawmakers’ controversial decision to decouple the bulk of the program’s tax incentive.

The OZ program — part of the Trump presidency’s Tax Cuts and Jobs Act of 2017 — had been a boon for development by providing investors both state and federal tax benefits, such as deferral and exclusion of capital gains taxes. Now, under a provision approved under New York state’s $212-billion budget in April, much of that state tax benefit is no more.

The move came as many critics decried the program as a handout for wealthy developers and likened it to corporate welfare. The nonpartisan Citizens Budget Commission estimated that in 2019, the OZ program was costing the state and New York City up to $63 million and $31 million a year, respectively.

“The Opportunity Zone program is a scandalous giveaway to wealthy developers who didn’t need the money to do the development, and I’m glad the state pulled ourselves out of wasting state dollars for this effort,” state Sen. Michael Gianaris (D-Queens) told media.

The decoupling will not impact residents of other OZ conforming states

There is more to the change than most realize, said tax attorney Jessica Millett, a partner at New York-based Duval & Stachenfeld LLP.

She noted that while the change obviously affects New York taxpayers, it shouldn’t impact non-New York residents who invest in New York OZ projects.

“The New York tax system works by starting with federal taxable income, and then adding back or subtracting out certain items to arrive at New York taxable income,” Millett said. “The recent changes eliminate any deferral benefit for New York taxpayers, but the deferral benefit is only relevant for the gain used to invest into a Qualified Opportunity Fund (QOF). So a New York resident with capital gain from selling stocks, for example, now has to pay state tax on those gains currently, even if the resident gets a federal deferral benefit for investing in a QOF.”

However, she added: “But a resident of a conforming state that has a capital gain from selling stocks can invest in a QOF that invests in a New York Opportunity Zone project without any adverse impact. That investor should get federal and state deferral benefits for the QOF investment, since the state that would tax those gains is a conforming state.”

Notably, New York lawmakers did not discontinue the 10-year benefit, which is the permanent exclusion of investment gain when taxpayers hold their OZ investments in a QOF for at least 10 years. 

“This may change or have been an oversight,” Millett added.

How the New York decoupling of the OZ incentive might impact the market

Matthew Rappaport, vice managing partner with New York-based Falcon Rappaport & Berkman PLLC, said he definitely sees less OZ investment happening in his state for the remainder of the program, which is set to expire in December 2026 (although a federal bill is looking to extend that by two years).

“It won’t cause people to leave the state, but it’ll cause money to leave the state, or at least not arrive in the first place,” Rappaport said. “For a state with a massive and dire housing shortage, I’m not sure how this makes sense.”

He advised a more “surgical solution,” such as restoring the state tax benefits for investments going into truly distressed communities. Part of the program’s criticism was that investor dollars weren’t getting pumped into economically disadvantaged areas.

Millett said she sees the future differently.

“Overall, I do not think the decoupling is going to move the needle on OZ investments in New York. New York is still a very attractive market, and if a deal makes sense economically on the fundamentals, it will attract capital. Additionally, the federal benefits are still greater than the state benefits, and we have seen other non-conforming states, such as California, do quite well with Opportunity Zone investments.” 

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