A Brief Primer on Opportunity Zones

You have likely heard the term “opportunity zones” tossed around in conversations, podcasts, or articles if you are following real estate related topics. You also might have wondered what these zones are, what are the benefits, and whether or not it is something you should dig into learning about. In order to get you up to speed, here are a few highlights to know about Opportunity Zones to help you understand them better and decide if you want to look into these opportunities further.

What Are Opportunity Zones?
Opportunity Zones are locally promulgated investment vehicles set up by Congress in the Tax Cuts and Jobs Act of 2017 to incentivize long-term, private capital investment in underdeveloped, low-income communities nationwide. By attaching tax incentives for investors, investments in the Opportunity Zones can help spur business development and community revitalization in target communities.

What Identifies An Area As An Opportunity Zone?
These investment zones are determined at the state level with various areas (tracts) nominated by the governor and evaluated/weighed by input of local interests with subsequent certification by the federal government. Many factors go into determining eligibility as an Opportunity Zone, but suffice it to say that it must be an officially designated Opportunity Zone tract that you invest in to reap the federal-level tax benefits.

Who Can Invest in Opportunity Zones?
Anyone! The main target for marketing the tax benefits of these zones has been individuals that have capital gains from another investment that they could roll forward into an investment within an Opportunity Zone and thus take advantage of the tax deferral and reduction on their gain rolled forward as well as the cost basis adjustment of any new gain on the Opportunity Zone investment; but any investor can participate in an Opportunity Zone investment.

What Are The Benefits of Investing in Opportunity Zones?
The 3 main tax advantages are as follows:
1. Deferral of Taxes – Capital Gain tax on an investment you are selling can be deferred if those gains are reinvested into an Opportunity Zone. This does not mean the capital gain goes away, but it does defer the tax on that gain until disposal of that property although other methods of tax deferral are still available (barring further tax code changes) at the exit of the Opportunity Zone investment.
2. Step-up in Cost Basis on the originally deferred gain at 5 and 7 year holding times – Deferred capital gains invested into these Opportunity Zones are eligible for a step-up in cost basis at 5 years (basis increase of 10%) and 7 years (additional basis increase of 5% for a total of 15% step-up). What does this mean? I’ll use an example to illustrate: If you roll forward $100,000 in capital gains into an Opportunity Zone investment, your original cost basis for tax purpose is $100,000. However, if this gain is re-invested in an Opportunity Zone, at the end of 5 years your taxable gain is 10% less, i.e. $90,000 and $85,000 after 7 years of holding the investment.
3. Permanent Tax Exclusion after 10 Years – The portion of gain incurred on the Opportunity Zone investment is excluded from tax IF the investment was held for a minimum of 10 years. This exclusion does not extend to any capital gains rolled forward (other than the reduction in taxable gain as outlined in point #2 above) but applies only to the gain on that portion coming from the Opportunity Zone investment itself.

How Do I Invest in Opportunity Zones?
Investments into Opportunity Zones must be made via Opportunity Funds which are entities set up by private businesses or individuals that go through a certification process to authorize their fund as being a certified Opportunity Fund. At least 90% of the fund’s capital must be invested in assets/businesses designated as Opportunity Zones and these funds are periodically reviewed for compliance. Naturally, there are many professional real estate companies coming in to fill the need for these required funds to be available for investors to invest through. These types of funds would work similarly to a syndication (see http://physicianrei.com/how-does-real-estate-syndication-work/ for more on how that works), but individuals do have the option of going through this certification process to make their own individual investments within their own Opportunity Fund.

Can I Invest Only in Real Estate Within Opportunity Zones?
No, these investments can be real property or businesses within an Opportunity Zone. If real estate, the real property must involve an original use of the property or incur a substantial improvement to the property in order to qualify and meet the purpose of an Opportunity Zone investment. Typically, that would be done through a new property being put into service or through rehabbing an existing property that is already in service.

So, what do you think? Do Opportunity Zones sound like something you might benefit from? As always, there are so many individual factors that go into determining what type of investment is “right” for each person. For me, understanding the tax implications is always relevant to helping me evaluate any investment and of course in this case that is the main incentive. Hopefully this article helped elucidate the basics of Opportunity Zones. Feel free to share your experience in researching or investing in these types of investments.

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