How Amazon can milk even more tax breaks out of HQ2

The dog and pony show that was Amazon’s “search” for the host city of its second headquarters helped it extract almost $3 billion in tax concessions out of New York’s state and local municipalities, not to mention another almost $1 billion from Washington, D.C., and Tennessee, but the windfall announced on Tuesday might only be the beginning.

That’s because the census tract in Long Island City where HQ2 (or HQ3) will be built is designated as an opportunity zone under a provision of the so-called Tax Cuts and Jobs Act, the tax overhaul President Trump signed into law almost a year ago.

Opportunity zones, the brainchild of Silicon Valley financier Sean Parker, allow people to invest capital gains—the profit made from the sale of an asset like a house, stock, or even a painting—in “distressed” areas and defer taxes on those gains until 2026. The idea is to direct capital investment to needy areas that haven’t benefited from the post-financial crisis recovery.

If they keep their gains in the investments for 10 years, the amount of the gain that’s taxable also drops by 15 percent. The spiciest meatball: Any gain made from investing in the area is not taxable at all, and you can invest in almost anything—businesses, commercial real estate, housing, or infrastructure projects.

Gov. Andrew Cuomo selected the section of LIC where HQ2 will reportedly land—which has a median income of $138,000, a poverty rate of 10 percent, and a bevy of new pricey shops, housing, and development—as an “Opportunity Zone” earlier this year under a provision of the law that allows governors to pick census tracts that are “contiguous” to distressed tracts.

That Amazon selected a site that was designated an opportunity zone can hardly be a coincidence, as investors, private equity firms, and venture capitalists across the country are licking their chops at the prospect of reaping tax benefits that one private equity manager described to Curbed as “crazy good.”

So is Amazon about to rig its operations to take advantage of opportunity zones and get even more free money from Uncle Sam? It’s hard to believe the company won’t try—and succeed—to some degree, but its options are somewhat limited given some of restraints in the law.

A generic example of the most lucrative setup would look like this: A real estate private equity firm would funnel its capital gains into its own Opportunity Fund, the newly created investment vehicle that will put capital gains in opportunity zones. The fund would invest in another real estate project and after 10 years flip said project for a profit, or a capital gain. The private equity group would defer taxes on the original capital gains until the sale, only 85 percent of the original capital gains would be subject to taxation, and they wouldn’t pay any taxes on the gain made from selling the real estate project.

How would this apply to Amazon? Amazon.com’s ecommerce business doesn’t inherently generate a ton of capital gains, so it’s unclear how much of its own capital it could plow into a fund. But Amazon could launch an Opportunity Fund to raise capital from outside investors and form a separate LLC for its real estate holdings in Long Island City and invest those capital gains in the headquarters building itself, which would allow the company or its investors to defer taxes on the gains until 2026 and reduce the taxable amount by 15 percent.

However, for Amazon or its investors to realize the biggest benefit—not paying taxes on the gain made from selling the building—it would have to sell its own headquarters or associated real estate sometime after 10 years of the gains being invested, which at least in the near-term is not likely. Companies do sell their old headquarters—for example, Curbed’s New York office is in Goldman Sachs’s old headquarters—so Amazon could use the program to make a long-term play for that eventuality.

Opportunity zones also allow investors to put their gains in a business instead of a real estate project, but for a business to be eligible, 70 percent of its tangible assets have to be within a zone, along with 50 percent of its gross income. Amazon has distribution centers and income from all over the world, so it would be practically impossible to reorganize in a way that would allow its business operations to be funded by Opportunity Zone Funds based on the 70 percent of assets rule.

However, Amazon could restructure one of its subsidiaries—for example Audible and/or Twitch, which don’t require huge real estate holdings like, say, Whole Foods—in a way that makes it eligible on the basis of locating in Long Island City. Then it could plow its own capital gains into its own businesses to defer and reduce taxes.

The opportunity zone law is purposefully open-ended so that municipalities can “tailor the program to meet their specific needs.” The United States Department of Treasury, which oversees the program, is still tying some of its loose ends through guidance releases, and one is expected to clarify the 50 percent of gross income rule. It’s possible something will change that allows Amazon to better capitalize on the program. Still, it appears for the moment that the scope of Amazon’s ability to take advantage of those tax breaks is relatively narrow.

One thing that’s almost certain to happen is that the land in Long Island City that’s designated an opportunity zone that won’t directly house an Amazon-owned property will be developed by opportunity zone funds, which will realize huge tax benefits from the program for putting up new shops or high-priced real estate.

The opportunity zones program has been criticized for not providing enough safeguards against misuse. While the intent is to have capital investments flow into underserved and distressed areas, critics say the more likely scenario is capital flows into a handful of zones already experiencing high growth—like Long Island City. The sudden influx of capital, they fear, will simply displace needy residents from the area, not actually help them.

Serving as a platform for Amazon to extract even more tax benefits for relocating to an already rapidly growing area of New York City would certainly be fuel for the program’s critics.