The Opportunity Zone (OZ) program is a relatively new federal tax incentive introduced by The Tax Cuts and Jobs Act in 2017. The policy behind the opportunity zone incentive is to encourage investors with capital gains to invest in low-income and undercapitalized communities — economically distressed areas that don’t get a lot of investment attention — in an attempt to promote
all-around rapid development of these communities (or tracts, as they are officially called).
Whether you are coming across opportunity zones for the first time or you have heard investors, asset operators and government firms talking about them, you want to pay attention to how you as an investor, or how your community or zone, can benefit from it.
My firm is currently working on a 5,000-acre industrial real estate opportunity zone development located in Reno that will be phased in over the next few years. It’s a $30-million equity investment. It not only has valuable railways going through it, but it is also located on two major interstate highways. The acreage is 90% flat, perfect for developing coveted data centers.
That’s the good news. The bad news is that not all investors will be able to participate. Only those who have capital gains that they can realize can opt to invest proceeds into opportunity zones such as these.
So, if you’re selling a business, or you’re looking for an excuse to sell a few shares of Amazon and Google that have appreciated several times, opportunity zones are perfect for you. In this piece, I will share a breakdown of what opportunity zones are, as well as the legal repercussions and structuring aspects of opportunity zones.
What tracts or communities are designated as opportunity zones?
Fifty U.S. governors, along with the mayor of Washington, D.C., nominated the zones, which were formally designated by the U.S. Department of the Treasury.
According to the Tax Policy Center, there are 8,762 tracts, making up 12% of U.S. census tracts, that are classified as opportunity zones. Some of the factors particular to these tracts are low income, high poverty and high unemployment rates. The value of real estate, as well as rent, is considerably lower.
What are the benefits of opportunity zones?
The opportunity zone incentive has three major benefits for investors:
1. Capital Gain Deferral
If you decide to take advantage of opportunity zones as an investor, you can temporarily defer taxes on capital gains that you have previously realized.
This means that the moment you put your active assets along with all the
capital gains you have amassed from them into qualified opportunity funds (qualified opportunity funds, also called QOF, are the investment mediums through which you can invest in opportunity zones) these capital gains will not be subject to taxation until the end of 2026. This only changes when you decide to sell the assets.
2. Partial Cancellation On Some of Those Capital Gains
This means you get a basic step-up on some of the capital gains you have placed in QOF. If you place your capital gains in the funds for a minimum of five years, you get a 10% increase on the basis of your primary investment. If you place your gains in the funds for at least seven years, you get a 15% increase on the basis of the primary investment.
3. Permanent Tax Exclusion On New Gains
This is the cake and the icing right here. When you invest in an opportunity zone for a minimum of ten years, the new capital gains you realize from whatever investment your money was used for in the opportunity fund will be tax free.
If you hold on to your investment for 10 years, any additional appreciation is tax-free — that’s a home run. If you are investing in a business or property that has huge potential for significant appreciation, you will have a field day with the profits in 10 years.
Can all investors claim opportunity zone incentives? What projects can you use opportunity zones
If you’re an investor with unrealized capital gains, you stand a chance of earning a lot of tax-free profit.
Real estate is currently the holy grail of these projects, but not all real estate projects can be financed by opportunity zones — only projects that aim to substantially improve the properties.
Opportunity zones come in different flavors, too. For example, an opportunity fund must have 90% of its assets invested into a qualified opportunity zone (QOZ) or qualified opportunity zone business. The rule for QOZ businesses is that 70% of the company’s assets must be in, you guessed it, a QOZ.
Recently, on April 17, 2019, the IRS clarified some opportunity zone regulations in an attempt to address the fears and confusion of many investors and to encourage more opportunity zone investments. The initial roles in the first kind of relations were unclear on what constitutes 50% of gross income being derived from a trade or business.
When do you have to have all your employees in the OZ? Do you have to make all of your products in the OZ? Do you have to only sell within the OZ? The IRS clarification largely revolves around the 50% rule, which is outlined below:
- In a qualified opportunity zone business, employees must spend a minimum of 50% of their billable hours working inside the OZ.
- Businesses that are not inside opportunity zones must have real estate located inside an OZ that contributes at least 50% of the business’s income to qualify.
- Contractors and employees paid by the business must receive these funds as a result of work done or conducted inside the opportunity zone.
The good news is you can reinvest in another asset. This gives people additional flexibility in opportunity zone investments.