Trinity Financial’s $64 million historic restoration of Lowell's Appleton Mills complex created 130 units of affordable artist housing. Gateway Cities offer opportunities for similar projects in their many downtown Opportunity Zones.

 Though often snubbed by real estate investors and homebuyers who prefer tonier communities, Gateway Cities are attractive to developers seeking tax incentives. 

The Massachusetts Housing Development Incentive Program (HDIP), enacted in 2010, confers special status on “gateway municipalities”; namely, cities and towns having 35,000 to 250,000 residents, with median household incomes and rates of attaining college degrees below the state average. The Massachusetts Department of Housing and Community Development (DHCD) recognizes 26 Gateway municipalities – Attleboro, Barnstable, Brockton, Chelsea, Chicopee, Everett, Fall River, Fitchburg, Haverhill, Holyoke, Lawrence, Leominster, Lowell, Lynn, Malden, Methuen, New Bedford, Peabody, Pittsfield, Quincy, Revere, Salem, Springfield, Taunton, Westfield and Worcester. 

To participate in the HDIP, municipalities must secure DCHD approval for “HD zones” established for multi-unit market rate housing. Upon DHCD approval, these municipalities may exempt from property taxes 10 percent to 100 percent of the increased value resulting from new construction or substantial rehabilitation in HD zones, for a five- to 20-year period.  

Qualifying projects must consist of at least 80 percent housing units available for sale or rent at market prices determined by DHCD. In addition to reduced real estate taxes, projects certified by DHCD qualify for income tax credits of up to 25 percent of construction costs (but not land acquisition costs).  DHCD authorized tax credits cannot exceed $10 million annually under this program. A modest 3,032 housing units have received HDIP tax credits since 2010. 

Combination with OZ Benefits 

The best neighborhoods for tax incentives are those where HD zones overlap with “opportunity zones” established under the federal Tax Cuts and Jobs Act of 2017. Massachusetts has 138 census tracts designated as Opportunity Zones, mostly in distressed neighborhoods. The tax law encourages investments in opportunity zones for new businesses and construction. These investments can qualify for three federal tax benefits, but the relevant tax laws are complicated. Prospective investors in opportunity zones should consult tax professionals. 

The following overly simplified example illustrates the federal tax benefits of Opportunity Zone investments. Consider a taxpayer who sells corporate stock or other investment property on Aug. 1, 2020, realizing a $3 million capital gain. On Dec. 31, 2020 (which is within 180 days after selling the stock), the taxpayer reinvests the $3 million capital gain into an easily created “Qualified Opportunity Fund” (QOF) developing investment property in an Opportunity Zone.  

By reinvesting the capital gain into the QOF within 180 days, the taxpayer can defer paying federal taxes on the gain until the first to occur: either the sale of the QOF investment, or Dec. 31, 2026. This tax deferral is the first tax benefit of the opportunity zone investment. The taxpayer’s tax basis in its QOF investment as of Dec. 31, 2020 is $0, because the taxpayer paid no federal tax on the reinvested capital gain. 

The second tax benefit provides a step-up in the taxpayer’s basis in the QOF investment, equal to 10 percent of the amount reinvested, if the taxpayer holds the QOF investment for at least five years. The step-up in basis effectively reduces the taxpayer’s capital gains tax by 10 percent. In our example, this second tax benefit enables the taxpayer to avoid capital gains tax on $300,000 of gain (that is, 10 percent of the $3 million reinvested in 2020). If we assume a 20 percent capital gains tax rate, our taxpayer enjoys a tax break worth $60,000. 

The third tax benefit is the most generous of all. If the taxpayer holds the QOF investment for at least 10 years (but not beyond 2047), the taxpayer’s basis increases to the fair market value of the QOF investment when the taxpayer sells it, and the taxpayer pays no federal capital gains tax on the sale! 

Christopher R. Vaccaro

Limited Time to Act 

However, the opportunity zone tax shelter has sunset provisions. First, the 10 percent step up in basis is unavailable for QOF investments made after 2021, because the investment cannot be held for five years before deferred capital gains tax is due on Dec. 31, 2026. Second, all opportunity zone tax incentives are unavailable for reinvested capital gains realized after 2026. The window of opportunity for opportunity zones is narrow. 

Real estate investors should pay special attention to downtown areas of Brockton, Fitchburg, Lowell, Lynn and Worcester, where overlapping HD zones and opportunity zones are within walking distance of commuter rail stations.  Considering available tax incentives and public transportation, some of those cities could become “the next Somerville” within a few years. 

Christopher R. Vaccaro, Esq. is a partner at Dalton & Finegold, L.L.P. in Andover.  His email address is cvaccaro@dfllp.com.