Federal tax break for the poor helps luxury developers on Kaua‘i

KUKU‘IULA — Wealthy investors in the Koloa and Hanalei real estate market could be in line for millions of dollars in federal tax breaks.

These areas are considered Opportunity Zones — a Trump-era program intended to pump investment cash into low-income areas.

Envisioned and championed by former Facebook executive Sean Parker, Opportunity Zones have been touted by supporters as means of driving business investment into capital-starved neighborhoods throughout the country using tax incentives for wealthy investors.

Yet critics of the policy have derided the program as too broad, with few limits on what areas can be chosen as Opportunity Zones, and what sorts of projects Opportunity Zone investments fund.

Brett Theodos, a senior fellow at the Urban Institute who has researched the effects of the policy, described it as “wide-open in terms of what it gets used for, who gets to use it and where it’s used.”

Though some of the most-distressed communities appear to have benefitted from the program — Opportunity Zone incentives have also funded projects that are definitively not community-oriented, like a warehouse to stash gold bars in Queens, a superyacht marina in West Palm Beach and a whole lot of market-rate and luxury housing.

Kaua‘i can be seen as a case study for these problems, where the “wide-open” nature of the policy has led to investment in a luxury resort and vacation-rental properties in areas not starved for development — particularly in the high-end real estate market at Kuku‘iula.

David Wessel, the director of the Brookings Institution Hutchin’s Center on Fiscal and Monetary Policy, and author of “Only the Rich Can Play,” which details the rise of Opportunity Zones, said that while these sorts of investments are legal — they are not in the spirit of the policy.

“They don’t serve the stated purpose of the program — to draw capital to impoverished communities and lift the fortunes of the people who live in them,” said Wessel.

“Taxpayer subsidies to build beach resorts and high-end vacation homes in the guise of helping poor folks is really bad public policy.”

Why Koloa and Hanalei?

The Opportunity Zone program was slipped into the Federal 2017 Tax Cuts and Jobs Act, a move that surprised Hawai‘i officials, who then had to quickly choose which 25 of the 351 eligible state zones would qualify.

Gov. David Ige had only about two months to pick the zones — not enough time to get public input on the process.

Based on 2010 census data, only two eligible zones were located on Kaua‘i — a South Shore zone that includes parts of Koloa, Lawai and Kuku‘iula, and a North Shore zone that includes Hanalei and Ha‘ena — two regions not thought of as particularly economically disadvantaged.

“Sometimes just using census-tract data can give you some weird results,” said Mark Ritchie of the state Hawai‘i Department of Business, Economic Development and Tourism, which worked to choose the zones at the time.

The income of non-resident investors is not included in the census calculation, and the two chosen zones are hotbeds of these sorts of properties, evidenced by median 2010 home values of $1 million and $668,000, respectively.

This, coupled with the relatively small population of the zones — 3,500 people live in the Koloa zone and only 770 live in the Hanalei zone — and a high number of retirees, is enough to skew the data to make them appear economically disadvantaged.

“(They) should not qualify as underserved areas, but they were given that qualification by the governor based on the income levels of the full-time residents,” said Kaua‘i County Councilmember Felicia Cowden. “The economic calculations do not consider the non-resident investor owners when evaluating the poverty level of the residents.”

Ritchie reported that when these areas were initially identified, representatives from the Kaua‘i Office of the Mayor and the county Office of Economic Development reached out to see if the zones could instead be placed in Hanapepe and Lihu‘e.

“We couldn’t do anything,” he said. “So Kaua‘i had the opportunity of saying they don’t want them and then another county could have taken those two. They finally just said, ‘OK, we’ll take them.’”

This strange classification of economically disadvantaged zones is not unique to the island.

“There have been some head-scratchers in terms of the zones that are chosen,” said Theodos, who noted that better-off communities in Portland, Oregon and Austin, Texas, and even New York City, had been picked as Opportunity Zones.

Better-off areas like these tend to be most attractive to investors, who see these places as safer bets. A study of 2019 tax returns showed that 78% of OZ investment went to the best-off 5% of zones.

Big tax benefits in Kuku‘iula

Investment in Kuku‘iula seems to have taken off following the implementation of the program.

“Our community has been flourishing from the recent Opportunity Zone investments at Kuku‘iula,” wrote Hawai‘i Life Real Estate Agent Lori Decker in a 2020 blog post. “Investors are purchasing ready-to-build homesites with the plan to improve the sites with vacation-rental homes in order to produce the business income required in the legislation rules.”

The previous year, Decker reported eight homesites had sold to Opportunity Zone Fund investors, at prices ranging from $585,000 to $1,750,000.

One potential Kaua‘i Opportunity Zone project is the Ohia, a $227-million luxury hotel proposed by Kupono Capital LLC, which declined to comment for this article.

First reported by Pacific Business News in 2021, the project was described as a “luxury resort and wellness center,” with 85 hotel rooms and 65 residences planned for its initial stage, with an additional 150 residences planned for a future phase.

Located behind the Shops at Kuku‘iula, it will be less than a five-minute drive from three other hotels, in an area not starved for development.

Investors in this project will be eligible for three tax incentives under the Opportunity Zone program.

The first allows them to defer paying taxes on capital gains from other ventures.

Rather than paying taxes now, investors can put that money in an Opportunity Zone Fund to be used for OZ projects, and defer payment until 2026 — saving money because, due to inflation, their taxes will be comparatively less valuable at that time.

The IRS also gives a discount on capital gains invested in an opportunity fund — 10% if the investment is held for seven years and 5% if it is held for five years.

Most significantly, if investors hold an OZ-funded property for 10 years, then sell it, they owe no taxes on the profits.

So, if the Ohia were to double in value over the next 10 years, and be sold, the investors would pay no taxes on the multi-million-dollar windfall.

Kaua‘i investors are likely to see some of the biggest gains, with Decker writing in another blog post that the island may have the “best potential for tax-free appreciation over the next ten years, in the entire State of Hawai‘i.”

Reforming Opportunity Zones

Ultimately, it is unclear how much money is going into these zones, since projects are not required to report whether they are using Opportunity Zone funds.

“It makes it very difficult to see what the economic impact is,” said Ritchie. “Otherwise, how do you know if something is successful of not?”

New legislation introduced in Congress this April — S.4065 and H.R. 7467 — would add some of these reporting requirements, while giving more tax incentives to investors.

This legislation would also exclude zones where the median income is 130% greater than the national median — but it does not appear that this would affect the Koloa and Hanalei zones, which feature median incomes of $71,000 and $39,000, respectively.

“The program got a facelift, but it needs an organ transplant,” said Theodos on the proposal.

He still sees the policy as a potential tool for economic growth, but not without more-substantial reform.

“If only mission-based funds were eligible, or if you could only develop affordable housing, or you have it only used in the most very distressed places, where any investment is good investment, I can get behind the policy,” said Theodos. “But being wide open on all of them means we have a waste of money.”

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Guthrie Scrimgeour, reporter, can be reached at 647-0329 or gscrimgeour@thegardenisland.com.