Opportunity Zone Investing

Real estate professionals should pay attention to the new federal initiative, the opportunity zones program. The program offers generous tax benefits in exchange for investment in low-income areas.¹ These incentives are focused on capital gains taxes.²

I. What are opportunity zones?

Opportunity zones are census tracts that meet certain low-income criteria and have additionally been nominated by the Governor of the state they belong to.³ The Economic Innovation group has set up a helpful map that can be used to search an address and determine if it is within an opportunity zone.⁴

Searchable Map from Economic Innovation Group

II. How does one invest in an opportunity zone?

To qualify for the tax benefits of investing in an opportunity zone, investors can not allocate money directly, but must instead go through qualified opportunity funds. Create a qualified opportunity fund according to Section 1400Z-2(d)(1) and invest in a qualified opportunity zone property.⁵

III. What are the benefits of investing in opportunity zones?

There are three main benefits for investing in an opportunity zone: 1) Deferring paying tax on prior capital gains; 2) reducing tax on prior capital gains; and 3) completely negating tax on future capital gains.⁶

The first incentive relates to deferring the payment of taxes on prior capital gains. Investors that realize capital gains (e.g. by selling stock or by any other way of obtaining capital gains) can reinvest their money in an opportunity zone fund and defer paying tax on their gain.⁶ The payment is deferred until the sooner date between 1) when the opportunity zone property is sold; or 2) December 31, 2026.⁷ (Note: there is a 180 day window after realizing capital gains to reinvest in opportunity zone.)⁸

The second incentive is related to reducing the tax on the prior capital gains.⁹ In addition to deferring payment, taxes on reinvested prior capital gains can be reduced if investors meet certain criteria:

1. If investment stays in qualified opportunity zone fund for at least 5 years: Basis of the original investment is increased 10% [aka original capital gains tax goes down].¹⁰
2. If investment stays in qualified opportunity zone fund for at least 7 years: Basis of the original investment is increased additional 5% (15% total) [aka original capital gains tax goes down even more].¹¹

Capital gains tax on the sale of an opportunity zone property can be entirely negated if the investment is held for at least 10 years.¹²

1. Note: this benefit is not related to the original capital gains tax, but is solely applicable to the reinvested capital gains.

Let’s take a look at an example:

Sample Opportunity Fund Investment

References

1. https://www.congress.gov/115/bills/hr1/BILLS-115hr1enr.pdf
2. https://www.irs.gov/pub/irs-drop/rp-18-16.pdf
3. http://www.agandruralleaders.org/talk-your-governor-about-opportunity-zones-your-state
4. https://eig.org/opportunityzones
5. https://www.irs.gov/pub/irs-drop/rr-18-29.pdf
6. Id.
7. https://www.thetaxadviser.com/issues/2018/dec/capital-gains-deferral-benefits-qualified-opportunity-zones.html
8. Id.
9. https://www.kitces.com/blog/qualified-opportunity-zone-qoz-fund-qof-defer-avoid-capital-gains/
10. Id.
11. https://www.cbiz.com/insights-resources/details/articleid/6536/are-qualified-opportunity-zones-a-golden-opportunity-for-avoiding-capital-gains-tax-article
12. Id.