States Decouple Opportunity Zones and Capital Gains

New York’s recently passed state budget included measures to decouple its capital gains tax code from the federal Opportunity Zones program.

Still, Sullivan & Worcester Partner Dan Ryan doesn’t see this as a widespread trend that should elicit significant concern. “There are not a lot of states that are doing this,” he says.

There were some notable exceptions, though. “When the Tax Cuts and Jobs Act [of 2017] came out a few years ago, California’s franchise tax board did a very lengthy report on what they were going to follow and what they weren’t,” Ryan says. “And, the opportunity zones were one thing that they weren’t going to follow.”

Otherwise, decoupling from opportunity zones has been a function of whether states have rolling conformity with the federal tax code or whether they conform to the tax code as of a certain date. For instance, Massachusetts conforms to the tax code as of 2006, according to Ryan.

“It’s not a conscious choice by the legislature to not follow opportunity zones,” Ryan says.

Ryan says New York and California are the only two states that tried to overrule or decouple separate from Opportunity Zones. “I haven’t really seen a big appetite among the States to not follow it,” he says. “It’s not something I think states pay much attention to.”

In New York, at least, Ryan thinks the motivation was political. “The only states that I can think of that made a conscious decision are California, when it first came out, and now New York,” he says. “Especially in New York, there has been, I think, a knee-jerk reaction that everything Trump did was bad.”

Whatever the motivations of these policies, Ryan says he hasn’t seen state tax regulations kill a project.

“In New York, the investors will have to pay more New York state tax,” Ryan says. “But it’s not going to prevent a project from going forward.  To be honest, the federal benefits are such that they offset any state tax considerations.”

If a project in New York is better, the tax policy probably won’t matter.

“Opportunity zones don’t make a bad project good,” according to Ryan. “Ultimately, 10 years from now, you’re going to want to sell it at a gain so you can get the tax-free appreciation in the project.”

But Ryan does think this policy could drive, at some point, drive development to other areas. “It may give developers some pause if there is an equally good project in, say Pennsylvania. It’s probably worth it to invest in Pennsylvania just because, if everything is equal, you’d want to save the tax money.”

In that way, the decoupling could ultimately end up hurting states like New York.

“It’s not just in New York City,” he says. “Throughout the state, opportunity zones have spurred investment. If your state wants to penalize people for doing that, it’s only going to hurt the state.”