“This round of regulations removes some of the most significant impediments keeping capital on the sidelines, especially as it relates to operating businesses.”John Lettieri, president of the Economic Innovation Group
Locating funding as a startup or small business can be a challenge. Investment capital for startups is at a premium, specifically venture capital in Nebraska. Small businesses of all kinds struggle in Nebraska to locate money that is active and ready for a risk. There is an exciting new opportunity, though, for organizations of all types seeking investment capital in Nebraska, or anywhere else in the United States. In April of 2017, the IRS released information on a new tax advantage for investors called Opportunity Zones. And in April of 2019, the IRS released new guidance, which makes it more attractive for investors to consider small businesses and startups in these opportunity zones.
What is an Opportunity Zone?
An Opportunity Zone is an economically-distressed community where investments may be eligible for preferential tax treatment. Opportunity Zones (often called OZ’s) are nominated by the state and approved by the federal government. They were added to the tax code in 2017 as a part of the Tax Cuts and Jobs Act.
It’s relatively easy to find out where Nebraska Opportunity Zones are located by visiting the Opportunity Nebraska website. They have a straight forward map showing the location of all zones. Nebraska was eligible to nominate 44 areas. To be nominated, an area poverty rate needed to be at least 20%, or:
- If located in a metropolitan area, the median family income can not exceed 80% of the greater of (i) the median family income in the metropolitan area or (ii) the statewide median family income, or;
- If located in a non-metropolitan area, the median family income can not exceed 80% of the statewide median family income.
How Do Startups Benefit From Opportunity Zones?
The new guidance as of April of 2019 from the IRS makes Opportunity Zones a lot more exciting for businesses of all types seeking funding in Nebraska. The short version of things: investors can place money into a qualified startup or small business and avoid some, or potentially all, capital gains taxes. But, to fully understand the opportunity for small businesses in Nebraska, we have to dig just a little deeper in the specifics.
According to the Tax Policy Center, the benefits to investors more specifically look like this:
- Deferral of taxes on previously earned capital gains
Investors place existing assets with capital gains into Opportunity Funds. Those capital gains are not taxed until the end of 2026 or when the asset is disposed of.
- Basis increase of previously earned capital gains
For gains placed for at least 5 years, investors’ basis increases by 10 percent. If invested for at least 7 years, the 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).
Capital gains taxes are paid on the difference between the sale price of an asset and its original price. There are, of course, all kinds of nuances that may be applied to reducing a tax burden, but let’s keep our math simple for a moment. If an investor places $100,000 into a startup and then exits that startup with a solid return of $750,000 after a few years, again, keeping things simple, that investor may be looking at a capital gains tax of 20% on the $650,000 gain. That’s a healthy $130,000 in taxes! Ouch.
But there is good news for our investor called an Opportunity Zone. If that investor was to move all of that realized gain into a new startup located within an OZ, they may reduce the taxable amount of that gain by 15%. Further, all of the gains on the new investment in the OZ could be free of capital gains tax. To do this, they would need to stay invested for ten years. There are pro-rated tax incentives for shorter investments. This accomplishes two important things: it reduces the immediate tax burden and creates more attractive returns on Qualified Opportunity Zone Businesses. Our example investor could save hundreds of thousands in taxes by using an Opportunity Zone Fund.
How do I qualify for Opportunity Zone investments?
The recent tax guidance from the IRS helps. Over the past two years, most Opportunity Zone funding was heading straight into commercial real estate. This was because investors were unclear on the rules around investing in companies. What if that startup sells products outside of an OZ? What if that small business has employees located outside of an OZ? These issues could cost investors significant dollars. Most of these questions have now been addressed, thankfully, so Nebraska Investors can move with more confidence.
According to the Wall Street Journal, “Under Wednesday’s rules, Treasury says a business can qualify if 50% of its employees’ hours or wages are in the zone.” Further, a business may qualify if its property and/or managers needed to produce 50% of its revenue are in an Opportunity Zone or if it can otherwise show that 50% of the revenue is generated in the zone. We call these companies Qualified Opportunity Zone Businesses (QZOB). So, if your company headquarters in a Nebraska Opportunity Zone, you are likely to be a prime candidate for these attractive investment funds.
Related: Omaha Startup Press for 2019
Where do I find Opportunity Zone Investors?
Any Accredited Investor may benefit from these Opportunity Zone tax incentives. We’ve written an extensive guide on how to find Angel Investors that you may want to check out. Many funds are forming with a focus on Opportunity Zones, and these Opportunity Zone Funds are the primary vehicle for investment in these areas. The new guidance gave these funds a grace period of about a year to invest in businesses, which has made them more attractive. This guidance is relatively new, though, and founders may find themselves having to explain the opportunity to potential investors. Sharing this article with them may be a great start.
Populus is located in an Opportunity Zone
And here’s a fun fact for you, Populus Coworking is situated within a Nebraska Opportunity Zone. This means that any business which moves at least 50% of its operations to Populus can be a Qualified Opportunity Zone Business and take advantage of these incentives. We will be encouraging Angel Investors in Omaha to take a look at Populus members for their next investment as it could save them thousands upon thousands of dollars.
Investing In Opportunity Zones Makes Nebraska Stronger
The tax incentives that Opportunity Zones provide investors are exciting for both founders and Angels. There is something deeper here, though, for Nebraska. Since the last recession around 2008, small businesses have been responsible for 100% of the net job growth in the United States. Put more simply; it is small businesses and startups that create jobs. Investing in companies within an Opportunity Zone will create significant job growth in those distressed areas. This is where the magic of this new plan could really drive meaningful impact beyond wealthy investors avoiding substantial tax burdens. This plan has the potential to create more meaningful returns for investors who help founders create jobs in distressed areas. According to CNN, the $2 trillion of unrealized gains that currently exist could benefit the rich and poor in a time when income inequality is rising. This is a new program and there will surely be much debate about its effectiveness in solving these income inequalities, but there is potential. That could be a massive win for Nebraska.
Disclaimer: This article is intended to help business owners make more informed decisions in regards to the topic; however, please contact an attorney for legal advice and an accountant for tax advice. Populus makes no representation as a legal advisor or tax advisor.