On December 22, 2017, the Tax Cuts and Jobs Act created a new section of the Tax Code that provides tax incentives for investments in targeted areas in the United States through investment vehicles called Opportunity Funds. The purpose of Opportunity Funds is to promote economic development in these select communities, known as Opportunity Zones, by offering investors substantial federal tax advantages that are only available through the new program.
1. What are the tax benefits an opportunity zone investment?
Capital gain deferral. A tax deferral for any capital gains rolled over in an Opportunity Fund. The deferred gain would be recognized before December 31, 2026, or the date on which the investment in the fund is sold.
Capital gain reduction. A step-up in basis for capital gains rolled into an Opportunity Fund. The basis of the original investment is increased by 10% if the investment is held by the taxpayer for at least five years, and by an additional 5% if held for at least seven years. In other words, if by December 31, 2026, an investor has held an investment in an Opportunity Fund for seven years, then the tax on the initially deferred gain is expected to be reduced by 15%, or reduced by 10% if by then held for only five years.
Capital gain elimination. In the case of any investment in an Opportunity Fund held by a taxpayer for at least 10 years, the basis of such property shall be equal to the fair market value of such investment on the date that the investment is sold or exchanged.
2. What qualifies as an opportunity zone investment?
Opportunity zone funds must be certified by the U.S. Treasury Department and hold at least 90 percent of its assets in a Qualified Opportunity Zone (QOZ) property. To invest in the distressed properties in urban and rural areas, a fund must be organized as a corporation or partnership. Opportunity funds are limited to equity investments in businesses, real estate, and assets that are located in a qualified opportunity zone. Loans are excluded from the tax incentives. The real estate in the fund must also need extensive rehabilitation.
3. Who can invest in an opportunity zone?
Investors with large capital-gains bills are appropriate candidates for these funds. Currently, most qualified opportunity zone investments are available to accredited investors. Investors are typically high-income earners, such as those with annual incomes of at least $200,000 who file with a single status or have a net worth above $1 million, excluding their primary residence.
4. How to invest in opportunity zones.
There are two ways to invest in an Opportunity Zone: you can either create your own fund, or you can invest in a third party's fund. The easiest way to invest in economic opportunity zones is through a fund. "The QOF must invest in a qualified business or property that meets the eligibility criteria, including commercial real estate or agricultural projects within the opportunity zone. Note that OZ investments are not limited to just capital gains and can pool eligible capital gains and "other capital." However, only investments of qualifying capital gains are eligible for the Opportunity Zone tax benefits.
5. What Assets Meet Requirements for Opportunity Zone Funds?
For an investment to meet the Opportunity Zone requirements, an asset needs to have been purchased after December 31, 2017. While the law has left some room for related party transactions, where you might sell the asset to a fund in which you also participate, the rules generally limit the seller to 20% or less of the fund. Also, 90% of the assets of a fund must be qualifying opportunity zone business property or an equity interest in a subsidiary that owns qualifying opportunity zone business property. Individual projects need to be a new development or involve renovations that double the value of an investment property.
Other Factors to Consider
There is uncertainty regarding the Opportunity Zone program, as the US Department of the Treasury has not released guidance on many of the questions left open by the Tax Cuts and Jobs Act of 2017. As the IRS continues to clarify regulations, it’s likely the additional opportunities will emerge.
Over the last several years, Greatwater has focused on investing in Detroit's neighborhoods. We have a robust pipeline of deals in Detroit's Opportunity Zones and will be bringing those investments to market soon. However, no investment in right for all investors. Do your research to fully understand if OZFs fit into your overall investment and tax-planning strategy. We recommend that prospective investors should consult with a personal tax advisor before making any investment into an opportunity fund.
Contact us at any time, we’d love to chat. You can also visit any of these helpful websites containing data referenced in this post.