IRS’s New Opportunity Zone Guidance Won’t Fix Program’s Flaws

New IRS guidance on how states nominate opportunity zones will revive a widely criticized program under the Tax Cuts and Jobs Act of 2017—but with looser standards that could amplify, rather than fix, original flaws.

The core architecture from the TCJA remains untouched. What is being changed is where zones can be drawn and how easy it is to qualify certain types of investments, especially those in rural areas. Absent substantial revision, OZ 2.0 risks continuing to see tax benefits allocated based on politics and geography rather than real economic need. The program should instead work to connect designation, investment, and outcome.

The program still encourages steering private capital into economically distressed communities by offering preferential tax treatment on capital gains. But if the first iteration taught us anything, it’s that political alignment and ease for investors dictates where the money goes more than statutory intent.

The new guidance looks less like course correction and more like a relaxation and weakening of investment standards, coupled with a preservation of broad discretion in zone selection by governors. That discretion is allocative, allowing state governors to determine which communities receive tax-preferred capital, with limited constraint beyond broad income-based thresholds.

Further, the statute permits the inclusion of some contiguous tracts that may not meet requirements but are adjacent to those that are. Taken as a whole, the same structural features that previously directed capital toward the easiest opportunities rather than the neediest ones stay intact.

The initial rounds of OZ activity didn’t fail for lack of interest—but it often seemed as though OZ designation followed, rather than led, private investment. Most economically significant activity occurred early in the program, as by 2021 the strongest tax-driven incentives had expired. When the dust settled, it was clear projects tended to cluster in areas already on the upswing, including downtown corridors, university-adjacent neighborhoods, and areas bordering gentrifying districts.

Those results were the predictable outcome of a program design that didn’t meaningfully constrain where or how returns could be generated. Investors pursued the highest risk-adjusted opportunities available—the safest bets among the lower-income tracts that qualified. The tax benefits thus functioned like margin enhancers for projects already viewed by investors as at least minimally viable rather than as a way to direct capital toward underserved areas.

The guidance does little to change that dynamic. Governors still must nominate eligible tracts, with significant room for discretion. That discretion was a central component of the first round—and a central source of criticism. Parcels in counties that supported a given governor’s campaign were more likely to get designation than those that didn’t.

Opportunity zone selection should be tied to uniform federal criteria that reflect measurable signals of economic distress.

Photographer: Michael Ciaglo/Bloomberg via Getty Images

Now, the revised “substantial improvement” standard for rural areas, effectively requiring investment equal to 50% of a building’s basis rather than 100%, lowers the bar for qualifying projects to a degree difficult to ignore.

It’s also difficult to substantiate from a policy perspective. The shift moves the requirement scale from something close to full redevelopment to an investment more akin to an incremental upgrade. More projects will clear the statutory hurdle, but likely fewer will reflect the kinds of transformative investment the policy aimed for.

The revised framework appears to contain nothing that would alter the underlying incentive structure that generated the first round’s outcomes. Investors will still receive the same tax advantages for deploying capital gains into qualifying projects, regardless of whether those projects meaningfully or durably change a community’s economic trajectory.

Given that, capital will likely keep gravitating toward locations where returns are most predictable—places such as growing metropolitan areas, transitional and gentrifying neighborhoods, and projects already near or beyond the threshold of viability. The guidance will do little to ameliorate concerns that investments are mostly subsidizing existing development trends.

If success is measured by the volume of capital deployed rather than its effects, it will be difficult to distinguish between projects that genuinely alter local economic conditions and those that simply sweeten ordinary development with tax preferences.

Opportunity zone selection should instead be tied to uniform federal criteria that reflect measurable signals of economic distress. Discretionary and strategic nominations should give way to empirical economic decision-making. And designated qualifying outcomes—such as net new housing units, commercial occupancy, or capital deployed into operating businesses—should replace governors selecting qualifying tracts.

On the investment side, restoring a more demanding “substantial improvement” threshold would better ensure tax benefits are aligned with projects that meaningfully transform underlying assets. If the program continues with a focus on qualified tract-selection rather than a defining of qualified outcomes, the retention of tax benefits should be conditioned on demonstrated community impact.

Outcomes such as real increases in housing supply, local employment levels, or small business creation could be tracked over time and benefits subject to claw-back if outcome benchmarks aren’t met. Combined with project-level transparency and public accountability, such a framework would shift the program from a passive subsidy for developers toward a more accountable policy tool with actual performance requirements.

The original OZ program showed where subsidized capital tends to flow. This iteration does nothing to internalize that information and adjust but simply accelerates that trajectory and re-aims it at rural projects. The program won’t fail to generate investment—but it could succeed on its own dubious terms while falling short on the publicly stated ones.

For policymakers who want OZs to function as more than just a retooled return-enhancement tool, the next step is clear: Tax benefits must be tied to measurable outcomes and allocation must be keyed to objective indicators of need. Otherwise, OZ 2.0 is little more than a gift to governors, especially those in rural areas, seeking to distribute valuable tax advantages without any requirement that they ensure capital reaches the communities the policy was meant to serve.

Andrew Leahey is an assistant professor of law at Drexel Kline School of Law, where he teaches classes on tax, technology, and regulation. Follow him on Mastodon at @andrew@esq.social.

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