Lenders who have historically provided capital to underserved areas – at the center of tax breaks in opportunity areas – have struggled to engage in the booming market for tax-advantaged investments.
Of the 1,100 community development finance institutions across the country, only a handful have managed to participate, and they cite a long list of obstacles, including an inability to take on investments themselves. According to community development professionals, elements of policy design and related IRS rules have excluded these institutions or made their job of leveraging incentives more difficult, while opportunity funds, including investors benefit from tax breaks, have raised billions of dollars to spend in the communities that CDFIs exist to serve.
Under a provision of the 2017 tax law, investors who inject profits into these funds to fund projects in about 8,800 census tracts can delay and reduce their capital gains taxes. Because the policy relies on capital gains tax benefits for long-term equity investments, many CDFIs are excluded, even if they are located in one of these census tracts.
Business Impact NW is a Seattle-based CDFI in one of more than two dozen opportunity zones in the city. A grant from the Small Business Administration directs Business Impact NW to run incentive training sessions, “but that’s really the only way we’ve really found a way to participate in it,” says Joe Sky- Tucker, executive director of CDFI.
“It’s almost impossible, as the statute has been written, for the CDFIs to actually participate in the benefits,” he said.
“Need for a new tax incentive”
One of the most frequently cited problems for CDFIs trying to get involved in the market is that opportunity funds make capital investments, taking ownership of the companies and projects they finance, rather than investing in them. grant loans as CDFIs often do.
“A new tax incentive is needed – one where the decision on what to fund rests with entities accountable to the community: Community Development Financial Institutions,” said Lisa Mensah, President and CEO of Opportunity. Finance Network, an association of over 300 CDFIs.
Of the handful of CDFIs that have entered the market, some say there is a demand for equity, rather than debt, among the companies they are helping start. But even the few CDFIs that have managed to take advantage of the Opportunity Zone Policy have faced challenges and want to see change.
Fundraising, strict rules
Investors place their profits in opportunity funds with the aim of reducing their tax liabilities and seek an increased after-tax return on these investments. While impact-focused opportunity funds certainly exist, the incentives grow with earnings, not with hiring, wages, or any other measurable community impact, making neighborhoods already hot and fast growing easier.
AltCap, a CDFI in Kansas City, Mo., created an opportunity fund as a separate entity known as Equity Squared LLC. But an education deficit has made fundraising difficult, said Emily Lecuyer, its chief executive. Opportunity zone incentives are often unfamiliar to those familiar with working with CDFIs, and opportunity zone investors need to understand how CDFIs work.
“Some investors prefer that we simply ask them for a donation,” said Lecuyer, who is also director of impact investing at AltCap.
CDFIs are often not-for-profit organizations, so equity financing from opportunity funds would not make sense in many cases. In addition to this, IRS rules (TD 9889) made final late last year include a requirement that effectively prevents CDFIs from qualifying as businesses eligible for opportunity fund capital.
Opportunity fund-backed companies cannot hold more than 5% of their assets in “non-qualified financial assets,” which include debt, stocks, and other financial instruments, which is not ideal for a financial institution. Under the rules and the law, respectively, these companies are also subject to tight deadlines to use all their money and more than double their base, or the value of the investment in them.
“It’s very hard for CDFIs to crack that nut, as a qualified opportunity investor or fund, unless you’re a very large CDFI, or you’re the direct recipient,” said Donna Gambrell, President and CEO of Appalachian Community. Capital – which successfully took advantage of the incentives – and a former director of the Treasury Department’s CDFI Fund.
This is because, she added, “the rules have not been structured so that these funds go directly to the CDFI, although I would like to see that”.
A Treasury spokesman did not immediately respond to a request for comment on the rules.
There are already calls from some Democrats to make changes. A bill (HR 7262) by Rep. Gregory Meeks (DN.Y.) would allow CDFIs to take advantage of opportunity fund investments by designating them as companies eligible for such financing. Yet only Democrats have backed the measure so far. Think tanks and other organizations unsuccessfully lobbied the IRS and Treasury to grant CDFIs this broad exception to some of the policy requirements while officials crafted the rules in 2018 and 2019.
And President-elect Joe Biden’s Opportunity Zone Reform Agenda aims to encourage “opportunity funds to partner with nonprofit or community-based organizations and jointly produce a benefits plan for the community for every investment” with an emphasis on job creation and directing the financial benefits to households in the areas.
“Needs Tweaking”
Some community development professionals have suggested that not only encouraging but requiring opportunity funds to partner with a CDFI or demonstrate experience in community development funding would be a good way to steer them towards institutions that execute the intent. politics. This is something the CDFI Local Initiatives Support Corporation and the Center for American Progress think tank advocated early in the regulatory process.
“Part of the refinement absolutely has to be focused on creating a program where more mission-based organizations can play,” said Maurice Jones, CEO and president of the Local Initiatives group, which has partnered with developers on opportunity zone projects.
There are many ways for CDFIs to adapt, said Michael Swack, who directs the Center for Impact Finance at the University of New Hampshire and co-authored a detailed report on the roles institutions could play on the market of opportunity areas. But until there are changes in policy to facilitate greater CDFI involvement in projects, he and others said, it is a brutal instrument.
“The initial idea was that they were going to be opportunity zones, and they would be targeted to low- and moderate-income communities, and that’s by geography, but not by any other targeting,” he said. he said, noting that his office, on a college campus, is in an opportunity zone. “Unless you have more precise targeting of beneficiaries, it won’t work.”
