There is a lot of talk about Opportunity Zones. Frankly, it is mostly more talk than action now, though that is changing. Real estate investors had not been provided much specific guidance from the IRS on what they can do with Opportunity Zones and how the near + long term mechanics of them work. There is enough info out there now, though still a few open questions. Some investors are jumping in to reap the benefits.
In a nutshell, Opportunity Zones are specifically defined areas that have low to moderate income populations who could benefit from economic stimulus. To encourage local investment of funds, improve local real estate, and build local businesses, OZs were created to entice investors via numerous tax benefits. If an investor significantly improves local properties or builds local business, they can take money from prior capital gains and get a tax reduction on those prior capital gains plus pay zero taxes on the new capital gains they have created through their efforts. Unlike 1031 exchanges, an investor can roll capital gains from stocks into a real estate acquisition in an OZ, and they can eliminate taxes on future capital gains. All are big wins, both for the communities in need and for the investors.
Why Were OZs Created?
OZs were created to incentivize investors to invest in and improve areas that could use economic stimulus via better real estate, new businesses and jobs, and a trajectory of growth and progress. This is a classic example of government using tools that it controls (tax benefits) to help direct external forces and funds (investors) to achieve societal goals (improvements in communities, employment, and citizen well being).
Where Are OZs Located?
They are located all over the country, in every state. Sometimes, they are in unexpected locations where the area would not generally be considered “low income” for the country though it may be considered “low income” in the context of other surrounding high income areas. They were all nominated for this designation by their associated state and then certified as an economically distressed community by the Secretary of the U.S. Treasury / IRS.
There are multiple online OZ mapping tools available, easily found via an Internet search. Click here for a good example. Then explore around your state and areas you know well to find where OZs are located. Think about why some areas were chosen and others were not. It is an interesting patchwork across the entire country.
What Are the Tax Benefits for Investors?
At a high level, here are the main benefits to investing in OZs:
- Temporary deferral of current capital gains taxes until 2026 (time value of money benefit)
- Tax reduction on those current capital gains (10% reduction after 5 years and 15% reduction after 7 years)
- Elimination of taxes on any new gains from OZ investments (if the OZ property or business is held for at least 10 years)
What Are Some Caveats?
There are details of tracking, accounting, entity formation, etc. that are best addressed on an individual basis with your tax attorney and/or CPA. Here are some high level considerations:
- The clock is ticking on the 5 and 7 year capital gains tax reduction options. Investments must to be made in 2019 for the 15% reduction, and made by 2021 for the 10% reduction.
- However, you can invest anytime from now through 6/30/2027 to get the benefit of no future capital gains taxes on your new OZ investment.
- The investment is intended to be sold by 2047.
- Investments must be made via a properly set up Opportunity Fund. This can be done by yourself with professional assistance, or you can participate in a larger organization’s Opportunity Fund.
What Can You Invest In?
- Real estate
- New construction
- Rehabilitation / significant improvement. You must at least double the cost basis of the improvements (not including land) from time of purchase.
- Business that operates and employs people primarily from the OZ (though it can serve areas outside the OZ)
- A small subset of business types are not allowed, such as casinos, race tracks for gambling, liquor stores, tanning salons, golf courses, country clubs, massage parlors, and certain financial companies
Are There Other Benefits For An Investor?
Yes! And some of these benefits are not directly tied to reinvesting capital gains or participating in an Opportunity Fund.
- The Small Business Administration has expanded their availability and terms of business loans for businesses in OZs
- The Department of Housing and Urban Development has implemented attractive incentives for multi-family investors in OZs
- Application fees reduced 50-67%
- Expedited and priority handling of loans
- More coming: There are 2 existing White House Councils that are centered around developing programs to encourage more investment in OZs
In Summary, How Can You Use This As An Investor?
- Defer taxes on sale of current property
- Reduce taxes on sale of current property
- Eliminate future taxes on sale of future OZ property
- Unlike a 1031 exchange, you can get these benefits also by selling stocks and reinvesting the capital gains in OZs
- Do you know anyone who would like to defer, reduce, and eliminate taxes plus inves