At the end of 2019, an estimated $75 billion in private capital was raised for investing in Opportunity Zones, due in large part to the incentives offered to investors. One of the biggest reasons why so much money is flowing into Opportunity Zone (OZ) investments may be the preferential tax treatment and benefits that investors receive.
In this article we’ll discuss the basics of Opportunity Zone investing, and how any investors facing a significant capital gains tax liability from the sale of stocks, a business, or real estate might benefit from investing in a Qualified Opportunity Zone.
What is a Qualified Opportunity Zone?
Qualified Opportunity Zones (QOZs) were created by the Tax Cuts and Jobs Act (TCJA) signed into law in December 2017. 1
While the Act created numerous incentives for individual taxpayers, investors and businesses by modifying existing laws, one of the most unique is the Qualified Opportunity Zone program. The initiative is specifically intended to grow investments and generate economic growth in lower-income areas of the U.S., and territories such as Puerto Rico. 2
Economic benefits of Opportunity Zones
- More than 15% of the people in the U.S. live in distressed areas targeted by the Opportunity Zone program, allowing investors to assist with employment and small business growth
- Distressed areas such as low-income inner-city neighborhoods, underserved rural communities, and areas adjacent to distressed areas benefit from the long-term investments that the QOZ program provides
- Investments include new development, rehabbing, or repositioning of assets such as infrastructure, industrial and manufacturing properties, and multifamily projects targeted toward the workforce housing rental segment
Tax benefits of Opportunity Zone investments
- Profits from the sale of any investment asset – including stocks, a business, or real estate – invested in a Qualified Opportunity Zone within 180 days from the asset sales date receive a full deferral of capital gains tax due through the end of 2026
- Additional capital gains tax generated from gains in QOZ investments held for at least 10 years are excluded from capital gains taxation
Opportunity Zone Criteria
There are more than 8,760 Qualified Opportunity Zones listed by the IRS in every U.S. state, the District of Columbia, and territories of the U.S. 3
During the Opportunity Zone selection process, governors of each state and territory, along with the mayor of Washington, D.C., nominated census tracts to the U.S. Department of Treasury to be officially designated as Qualified Opportunity Zones. Criteria used in the selection process included: 4,5
Income and poverty levels
- For urban areas, median family income in the census tract of 80% or less of the metropolitan or statewide median family income
- For rural areas, median family income in the census tract of 80% or less of the statewide median family income
- Poverty rate in the census tract of at least 20%
Qualification of adjacent census tracts
The IRS also allows Qualified Opportunity Zones in census tracts that are not located in low-income areas. However, the census tract must be adjacent to a low-income QOZ and have a median family income of 125% or less of the median family income in the neighboring low-income census tract.
Top Reasons for Investing in an Opportunity Zone
Unlike a 1031 tax deferred exchange which is limited to real estate investors, any investor facing a capital gains tax bill can defer the tax by investing in an Opportunity Zone.
This means that people who have taxable gains from the sale of assets such as stocks and bonds, artwork, cryptocurrencies, gold and silver, and of course investment real estate, can receive benefits now and over the next several years by investing in an OZ:
- Payment of capital gains taxes is deferred until the 2027 tax year
- Additional gains from Opportunity Zone investments are not subject to capital gains tax, provided the investment is held for at least 10 years
- Unlike a 1031 exchange which requires all net sales proceeds from a transaction to be reinvested, only the capital gains portion from a sale must be invested in an OZ in order to receive preferential tax treatment
- For real estate investors, investing in an Opportunity Zone may be an attractive alternative by offering 180 days to identify and invest in a replacement property, versus the more strict 45-day identification period required in a 1031 exchange
Additional Incentives of Opportunity Zone Investments
State and local governments may also offer additional incentives for Opportunity Zone investments based on the needs of the local community. In the Opportunity Zones Best Practices Report presented to the President earlier this year, the White House Opportunity and Revitalization Council described some of these local initiatives: 6
- Some states offer property tax abatements of up to 10 years for renovations and improvements made to existing commercial buildings
- Cities and towns may modify parking requirements and allow higher densities for affordable housing developments located in an Opportunity Zone
- Municipalities encouraging the development of workforce housing ensure that certain percentages of multifamily units are affordable for tenants such as teachers, police and firefighters, and government employees
How to Invest in Opportunity Zones
A Qualified Opportunity Fund (QOF) may be the easiest way for most people to invest in a Qualified Opportunity Zone. The IRS defines QOFs as investment vehicles specifically organized for the purpose of investing in property located in an Opportunity Zone: 7
- At least 90% of a Qualified Opportunity Fund’s assets must be held in a Qualified Opportunity Zone
- Main asset types held by a QOF are real estate used for business or investment, the stock of a company located in a Qualified Opportunity Zone, or a partnership interest in a business located in a Qualified Opportunity Zone
- The Qualified Opportunity Fund must be certified by the U.S. Treasury or self-certified according to guidelines published by the IRS
Realty Mogul, Co. and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. See offering documents for additional details, disclosures, and disclaimers.
References and resources
1. https://taxfoundation.org/opportunity-zones-what-we-know-and-what-we-dont
2. https://eig.org/wp-content/uploads/2017/09/2017-Distressed-Communities-Index.pdf
3. https://www.irs.gov/pub/irs-drop/n-18-48.pdf
4. https://www.law.cornell.edu/uscode/text/26/45D
5. https://codes.findlaw.com/us/title-26-internal-revenue-code/26-usc-sect-45d.html
7. https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions