Among the many provisions included in the Tax Cuts and Jobs Act (TCJA) was the creation of a new type of community-development designation, referred to as Opportunity Zones. As defined by the IRS on their website, an Opportunity Zone is “an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatments.” The goal of this program is to spur the private investment required to breathe life into these struggling economies via real estate tax credits and incentives.
What are Qualified Opportunity Zones?
Qualified Opportunity Zones (QOZs) are tracts of land selected by the governor of each state, then certified by the U.S. Department of Treasury. So far, approximately 9,000 Qualified Opportunity Zones have been designated, across the United States. Visit the U.S. Treasury’s Opportunity Zones Resources page to view a map of all currently designated Qualified Opportunity Zones.
How Does the Opportunity Zone Program Work?
The Opportunity Zone program allows the capital gains from the sale of an investment to be rolled into a Qualified Opportunity Fund (QOF), which the IRS defines as “an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in an Opportunity Zone.” Money invested into a Qualified Opportunity Fund within 180 days of the sale of an investment stays, in effect, unrecognized while it remains in the fund.
Not only can an investor defer tax on the capital gains reinvested in the Qualified Opportunity Fund, but also, if the funds are held for a set number of years, the investor becomes eligible for tax savings on a step-up basis (an effective reduction in the amount of capital gains finally recognized). Here’s a quick overview of the savings timeline:
|Years Held in Qualified Opportunity Fund||Tax Benefit|
|5 years||10% step-up basis|
|7 years||15% step-up basis|
|10 years||15% step-up basis + permanent exclusion of gains made post-contribution|
In addition, investors can defer tax on any prior gains invested in a Qualified Opportunity Zone until the earlier of the date on which the investment in a Qualified Opportunity Zone is sold or exchanged, or Dec. 31, 2026.
Please note that the program requires a minimum of 90% of the assets of the Qualified Opportunity Fund to be Qualified Opportunity Zone property. Additionally, this incentive went into effect on Dec. 31, 2017, so the amount invested in any pre-existing property (property purchased prior to the program’s effective date) must exceed the investor’s basis in the property in order to qualify.
What Are the Benefits of Qualified Opportunity Zones?
Despite numerous regulatory guidelines pending final approval, Qualified Opportunity Zones present a unique investment strategy. Not only does investment in Qualified Opportunity Zones bring financial savings to taxpayers, but also has the potential to have a tremendous positive impact within communities across the country.
What Should Investors Be Cautious About?
While Opportunity Zones offer enticing benefits, tax savings should not be the only factor influencing the decision to invest or break ground on a new development. A bad deal is still a bad deal, and not all qualified investments are worth pursuing. As investors scope out Opportunity Zones, they should assess the potential investment with the same level of due diligence they would use for any other deal. Questions to consider include:
- Are the area’s property values and income levels likely to grow?
- Does the developer or business have an established track record?
Investments in Opportunity Zones also have associated risks, just like any other investment. Larger qualified Opportunity Zone Funds and ones established by experienced real-estate owners and developers like REITs will have an advantage in this arena.
What Else Do I Need to Know?
Numerous regulatory guidelines are still pending final approval. With that being said, to maximize the potential benefits, taxpayers must invest in a Qualified Opportunity Fund before Dec. 31, 2019. So, while investors shouldn’t blindly rush into Opportunity Zones, the clock is ticking to take full advantage of the tax savings.