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Chip Smith

‘Confidential’ re-zoning in Myrtle Beach raises ownership questions

City Council passed first reading of a re-zoning request on 2 acres of land along 14th Avenue North between Chester Street and Withers Drive. The property is planned as for “a mix of family-centric uses.”

Who owns the land?

Checking property maps on file two weeks past, the land was listed under the name of former Downtown Redevelopment Board member Chip Smith.

In checking the most recent property maps listings, today, however, the property is listed under CPC Oceanfront Delaware, LLC. The land has clearly been transferred. As to the timeline of that transfer, details are unclear.

When did questions about ownership become accusing?

Picking Winners and Loser

Concerns were raised today by downtown merchants. Ocean Boulevard business owners believe the city of Myrtle Beach is selectively using zoning as a weapon to pick winners and losers among merchants inside the city limits. Lawsuits have been filed and are waiting trial dates.

We asked the city to cite 5 occurrences when zoning approvals like the above were recently approved.

Myrtle Beach City Manager John Pedersen reached out to us with the following:

“Once zoning is assigned to an area, then any use permitted in that zone is allowed.  Within the list of permitted uses, the applicant is not held to a specific site plan, nor is a subsequent owner required to conform to the original applicant’s plans.  In an Amusement zone the property owner could put in a merry-go-round initially, and then replace it with a tilt-a-wheel down the round without having to ask the City for a rezoning.     

In this specific case, in addition to an actual amusement, the developer has asked to develop housing (a permitted use in the A Zone) using the setbacks allowed in the A zone, which are less restrictive than those in the current MuH zone.  Both Planning Commission and staff agreed that a loud amusement (such as a roller coaster) is not compatible with the current library, a church or a school, so they have specifically prohibited any such loud amusements within 220’ of the library, church, or a school.  I do not know what amusement the applicant has planned.  It could be any of the examples indicated above, or something completely different.  That has no bearing on staff’s analysis of the request. 

Occasionally a developer wishes to create a completely unique set of permitted uses, setbacks, signage restrictions, landscaping plans, parking requirements, etc.  These hybrid models are considered as Planned Unit developments (PUDs).  Because the details of the approval are crafted for a specific site plan, the developer is held to delivering exactly what is in the site plan.  Any significant change must be reviewed by Planning Commission and City Council before that change can be made.  The recent issue involving connectivity in the Grande Dunes PUD is such an example.  Had that not been in a PUD, no zoning amendment would have been required.

In short, the answer to [your] request for 5 examples is that we have no absolute assurance what is going to be built for any rezoning application, with the exceptions of PUDs (which this is not).  I am unaware whether Chip is involved in this project or not.  My conversations have exclusively been with the gentleman that appeared yesterday.”

PROJECT TO BE BUILT USING “OPPORTUNITY ZONE” TAX INCENTIVES?

City Public Information Officer Mark Kruea also responded, stating, “Zoning itself is not project-specific.  This is an extension of the adjacent Amusement zoning.  Take any commercial rezoning, for example.  We don’t know (and don’t need to know) the names of each of the retail stores or restaurants that may be built on the property.  We don’t need to know what they will be selling and serving.  Why?  Because the parameters of the zone itself – what the code allows and what it doesn’t – will address those details.  That’s why the Zoning Code exists, to spell out in detail what sort of uses are permitted; under what terms and conditions, if any, they are allowed; what heights and setbacks are allowed and/or required; and which uses are compatible with other uses as next-door neighbors.  Zoning is the process of determining which general uses go where, not which specific projects go where.  A Planned Unit Development (PUD) generally is more specific and often does include that sort of detail about projects, building heights, amenities and public benefits due to the give-and-take nature of PUDs, but the rezoning considered this week was not part of a PUD.  As you’ll see in the attached file, which is the ordinance approved on first reading, the text of the zone is specific about what is allowed and where it’s allowed in the A or Amusement Zone.   Knowing exact details of the project is not required, as long as the ultimate use conforms with what’s allowed in that zone.

The city sent over a laundry list of attachments which corroborated Kruea’s statement. The issue of using Opportunity Zone Taxes stood out.

OPPORTUNITY FUNDS MUST BE INVESTED BEFORE 2020

THE RISKS OF OPPORTUNITY ZONE INVESTMENTS

The property in question is located in a tax incentive “Opportunity Zone”. The Center of Budget and Policy Priorities warns about the “Potential Flaws Of Opportunity Zones” in its January 2019 report as below:

The 2017 tax law created a new tax break to encourage investment in low-income areas (“opportunity zones”) but, as high-profile Wall Street, Silicon Valley, and real estate investors rush to profit from it, critics are raising sensible concerns about the policy:

THE TAX BREAK INCLUDES NO REQUIREMENTS TO ENSURE THAT LOCAL RESIDENTS BENEFIT FROM INVESTMENTS RECEIVING IT.

  • The law enabled state policymakers to designate relatively affluent areas as opportunity zones, which could divert investment from truly disadvantaged communities.
  • While the new tax break enables investors to accumulate more wealth, it includes no requirements to ensure that local residents benefit from investments receiving the tax break. Thus, this tax break could amount to a “subsidy for gentrification” in many areas instead of, as intended, for providing housing and jobs for low-income communities.[1]
  • Potential loopholes in the law and an initial set of proposed Treasury regulations — which investors are now lobbying to re-shape — could enable investors to secure the tax benefits while generating little real economic activity in the opportunity zones. The scope of potential tax avoidance — an issue that hasn’t received enough attention to date — will become clearer as Treasury finalizes its first set of regulations and releases additional guidance on how to comply with the law.
  • The new tax break will cost an estimated $1.6 billion in lost federal revenue over ten years, according to Congress’ Joint Committee on Taxation,[2] but the costs could be significantly higher after the first decade because, as explained below, some of the most generous tax benefits extend far into the future.[3] Moreover, the extent to which the $1.6 billion figure accounts for large-scale tax avoidance isn’t clear.

For these reasons, the tax break risks exacerbating the three main flaws of the 2017 tax law itself: it mainly benefits wealthy investors instead of workers and residents of distressed communities, reduces federal revenues and makes our long-term fiscal challenges worse, and creates new opportunities for tax avoidance.[4]

Congress hastily drafted and passed the 2017 law without public hearings or broad expert input, and the new tax break for opportunity zones was among the provisions that didn’t receive nearly the attention they deserved. The President and Congress should take the time now to consider how to ensure that the benefits of this new tax break go to those who need them most, rather than creating “mini tax havens for the wealthy.”[5] In its upcoming rulemaking, Treasury should focus on limiting investors’ ability to use opportunity zones to avoid taxes without undertaking any activity that could potentially benefit distressed communities and their residents.

Who Can Invest in Opportunity Zones?

The opportunity zone provision offers tax benefits to investors with unrealized capital gains — gains in the value of investments, like stock, that the government hasn’t yet taxed because investors haven’t yet sold them. Under the provision, investors who sell such investments can defer the capital gains taxes that are otherwise due by “rolling” the amount of the gains into funds (known as opportunity zone funds) that would invest in opportunity zones.

Investors can take advantage of the new tax break for opportunity zones in up to three ways. First, investors can defer taxes on their capital gains until 2027 if they invest their gains in opportunity zone funds. Second, those who hold their opportunity zone investments for at least seven years also will get a 15 percent cut in the capital gains taxes that they would otherwise pay (on top of the generous tax break that the low capital gains tax rate already gives them). Third, and perhaps most significant, those who hold opportunity zone investments for at least ten years will get a permanent capital gains tax exemption for all of the gains they realize on their opportunity zone investments through 2047.[6]

Due, in part, to the complexity of the opportunity zone rules, large investment funds that raise capital from individual investors will create and manage most opportunity zone funds. These investment funds will select the investments, and investment structures, that offer the best prospects for financial returns while satisfying the opportunity zone criteria.[7]

Under the rules, opportunity zone funds must invest 90 percent of the capital they raise from investors in the following types of property:

  • physical assets, such as real estate or equipment, that are located in opportunity zones; and/or
  • ownership interests, such as stock, of businesses that operate at least partially in opportunity zones (referred to as opportunity zone businesses), including subsidiaries of larger businesses that largely operate elsewhere.[8]

The other 10 percent of capital that an opportunity zone fund raises isn’t subject to any restrictions so, for example, it could invest in physical property that’s located outside of an opportunity zone.

Some opportunity zones will choose to invest solely in opportunity zone businesses, while others will choose to own assets, such as real estate, in opportunity zones rather than acquire ownership interests in opportunity zone firms. Still others will choose some combination of both. Different requirements apply to the ownership of each type of property, however. Opportunity zone businesses, for example, may not operate certain types of businesses (such as so-called “sin” businesses like massage parlors, gambling facilities, or liquor stores), but the rules don’t prevent an opportunity zone fund from, say, directly owning and operating a casino. Like other distinctions, this one rests on no obvious policy rationale.

Furthermore, many of the requirements are ambiguous. One rule, for instance, requires that opportunity zone businesses “derive” at least half of their overall income from an “active business” located in an opportunity zone. Neither the law nor the proposed regulations define the terms “derive” or “active business.” Such ambiguity creates a wealth of opportunities for fund managers to game the system as they plan their investment structures, such as by stretching the boundaries of what the term “active business” means. In addition, and as discussed below, opportunity zone investment may not significantly benefit low-income communities — supposedly the target of the opportunity zones — whether the zone funds own assets directly, acquire ownership shares in opportunity zone businesses, or some combination of the two.

Designation of Opportunity Zones Failed to Target Neediest Places

Since policymakers enacted the 2017 tax law, governors (and the District of Columbia’s mayor) have designated about 8,700 opportunity zones in states and territories, including Puerto Rico. Governors, who have now completed the selection process, had to choose most of these zones from localities that qualify as “low-income communities,” meaning that they have either a poverty rate of at least 20 percent or a median income that’s no greater than 80 percent of the median income in their metropolitan area.

This definition of “low-income community” is broad enough to include some areas that are not truly distressed, such as areas adjacent to some elite colleges — for example, the University of Virginia and the University of California at Berkeley, where a large concentration of students skews the income data. Furthermore, the law lets governors designate a subset of areas that are adjacent to a low-income community and have a median income of no more than 125 percent of the median income of the adjacent low-income community. Thus, they could designate as opportunity zones a number of areas that many would not consider “distressed” — including Long Island City, where Amazon is moving one of its new headquarters.[9]

Opportunity zone advocates note that, on average, designated opportunity zones have a higher poverty rate and lower household income than the national averages, but those averages mask an important fact: While most opportunity zones do face above-average levels of economic distress, many of the selected tracts are relatively affluent or have other structural advantages that made them ripe for investment even before the new tax break was created.[10] For example, rapidly gentrifying areas of Oakland, Los Angeles, and New York City have qualified as opportunity zones, as has part of the Las Vegas Strip where a new NFL stadium is expected.[11] While such areas may represent a small share of opportunity zones, the rules don’t prohibit opportunity zone funds from investing exclusively in the most affluent zones. Thus, these “outlier” zones could attract a significant share of the opportunity zone investment and come to account for a disproportionate share of the lost federal revenue.

Program Mechanics Don’t Guarantee Local Residents Will Benefit

Because taxpayers must have unrealized capital gains to invest in an opportunity zone, and capital gains are heavily concentrated among the wealthy, the tax break will directly benefit wealthy private investors. Local residents of opportunity zones will benefit only to the extent that the tax break encourages new investments (not those that would have occurred anyway); creates jobs for residents; spurs the development of new, affordable housing; or creates broader economic improvements that reach local residents.

Unlike some other economic development incentives, however, this tax break does notinclude rules or tests requiring its direct beneficiaries to make specific investments that actually produce public benefits or requiring that opportunity zone businesses hire workers from, or provide services to, the local community. If anything, its incentives push in the opposite direction: the tax break is worth the most with respect to investments whose value rises the fastest. As a result, investors will likely select investments — such as luxury hotels rather than affordable housing — based mainly on their expected financial return, not their social impact.[12]

Indeed, in pitching to potential investors, former Trump White House Communications Director Anthony Scaramucci characterized one of his investment firm’s projects in an opportunity zone in Oakland as “building a swank, boutique hotel that’s going to create excessive economic rents.”[13] Similarly, Cadre, a New-York-based real estate investment firm, announced plans to invest only in a subset of opportunity zones in metropolitan areas with “outsized future growth potential” — in other words, in cities that are already expected to grow economically and likely don’t need help in attracting investment.[14] Not surprisingly, then, analysts warn that the new tax break could accelerate gentrification — and, hence, the dislocation of current residents — and create few jobs.[15]

As noted, the law requires that opportunity zone businesses “derive” at least half of their income from an “active business” in a zone. Neither the law nor the regulations, however, explain what that means. Consider the following: A large, multinational software company that’s headquartered in Silicon Valley locates a new subsidiary in an opportunity zone and moves a handful of its existing software developers into the subsidiary, but it continues to employ most of its workers outside of opportunity zones. The subsidiary earns income by licensing software that’s developed in part in the opportunity zone back to the parent company in Silicon Valley, which then sub-licenses it to customers around the world. Is the company’s resulting income “derived” from a business in the opportunity zone? As Treasury develops additional regulations clarifying this and other ambiguities, it should do so in ways that provide the greatest benefit for local residents.

Ambiguous, Arbitrary Rules Raise Questions of Tax Avoidance

Opportunity zones also bring the potential for loopholes that encourage tax sheltering and other forms of tax avoidance. As a starting point, the proposed regulations let an investor get the full tax break even if only 63 percent of the total capital that an opportunity zone fund invests flows to a zone.[16]

Beyond that, pure gaming could limit investment in opportunity zones even more. For instance, there is a question about the extent to which a firm that relies on intangible property, such as intellectual property — which is typical for a technology startup or pharmaceutical company — can use accounting or other gimmicks to make it appear that it developed the intangible property in an opportunity zone, even if the actual location of the company’s activities hasn’t changed much. Such a maneuver could enable the company’s investors to avoid taxes on any gain in the value of their intangible property.

The scope of such gaming will depend in part on how Treasury regulations interpret several of the law’s vague requirements, including that businesses locate certain amounts of physical property (such as real estate and equipment) in the zone, that a certain amount of intangible property be used in an active business in an opportunity zone, and, as discussed above, that a certain amount of income earned by opportunity zone subsidiaries be “derived” from the active operation of a business in an opportunity zone (as opposed to investors merely, or “passively,” holding assets located in a zone). Treasury should mitigate potential abuses by issuing regulations that limit investors’ ability to extract tax breaks from opportunity zones that don’t result from real investments in them.

Treasury regulations cannot prevent all abuse, however; many tax avoidance opportunities are inherent in the tax break itself. As noted in the Appendix, for instance, the law imposes vastly different requirements with regard to opportunity zone funds that contribute capital to opportunity zone businesses, as distinguished from an opportunity zone fund that directly owns physical assets in an opportunity zone. That will likely encourage investors to game the rules and take advantage of the tax break in any possible way.

Conclusion

The direct tax benefits of opportunity zones will flow overwhelmingly to wealthy investors, but the tax break might not do much to help low-income communities, and it could even harm some current residents of such communities.

In the near term, Treasury should issue regulations that reduce the potential for opportunity zones to serve as pure tax shelters. Regulatory ambiguity in what constitutes qualifying activity in an opportunity zone could open the door for large-scale tax avoidance. Regulatory fixes alone, however, can’t address the problems that stem from a law that gives governors and investors substantial leeway to determine what investments qualify for the tax break. Accordingly, Congress should exercise its oversight authority to carefully consider how the program is working, who is actually benefitting, and how it can prevent widespread tax avoidance — and policymakers should make appropriate adjustments to the law based on the findings.

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About David Hucks

Born in 1961, David is a 12th generation descendant of the area we now call Myrtle Beach, S.C. David attended Coastal Carolina University and like most of his family, has never left the area. David is the lead journalist at MyrtleBeachSC.com

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