Here’s What You Need to Know about Investing in Opportunity Zones
The government wants to help spur development and economic revitalization in economically distressed areas. Investing in opportunity zones may qualify for preferential tax treatment.
For those who want to invest in underserved communities while benefiting from tax advantages, investing in Qualified Opportunity Zones can be the right choice. The program allows you to defer your capital gains tax liability by putting that money into qualified opportunity funds.
As you begin to investigate this process, be sure to work with your tax and legal counsel. This article provides general information, not investment, legal or tax advice.
Here’s how Qualified Opportunity Zones work at a glance.
What are designated Qualified Opportunity Zones?
Qualified Opportunity Zones (QOZs) were developed as part of the Tax Cuts and Jobs Act of 2017. They were designed to push investment, development, and job creation into underserved communities. Individuals or businesses who invest their capital gains in a QOZ get preferential tax treatment and advantages. As with anything regulated by the U.S. government, the IRS has a very specific definition for designated Qualified Opportunity Zones.
Since the first set of QOZs (in 18 states) was designated in 2018, QOZs have popped up in all 50 states, the District of Columbia, and five U.S. territories. To designate a QOZ, states nominate blocks of low-income areas by census tract. These are certified by the Secretary of the U.S. Treasury via his/her delegation of authority to the Internal Revenue Service. To see current QOZs, visit the IRS’ Qualified Opportunity Zones map. According to the Economic Innovation Group, numbers vary by state. California has 879 while Georgia has 260, based on recent numbers.
What is the purpose of Qualified Opportunity Zones?
The goal of QOZs is to kickstart economic development and job creation in certain distressed areas. They do this by providing tax incentives for investors who invest new capital in businesses in these zones. Done properly, it’s a win-win: a great tax savings for investors and a boost to communities across the country.
How underserved communities benefit
Drawing outside investment to communities that need investment dollars has the potential to spur economic activity. The intent behind renovation projects in these communities and other upgrades is to make these areas more attractive to potential homeowners and businesses over time. Additionally, members of the community may see increased jobs available in related fields as projects go underway. Even when construction is complete, the skills remain to find future opportunities.
How to invest in a Qualified Opportunity Zone
You can’t simply use your capital gains money to buy a property in a QOZ and expect a tax benefit. Instead, you need to invest in a Qualified Opportunity Fund that will then invest or buy a property. Work with experts on QOZ funds to make sure it’s set up correctly. To qualify, you’ll have to put the proper amount of investment into the properties once they’re purchased to qualify for the tax benefits (generally at least the amount of the purchase price within 30 months). And you can’t sell your investment right away either: to get the maximum tax benefit, you’ll need to hold it for 10 years or more.
Practically speaking they offer tax benefits in two ways, according to the IRS:
- “An investor can defer tax on any prior eligible gain to the extent that a corresponding amount is timely invested in a Qualified Opportunity Fund (QOF). The deferral lasts until the earliest of the date on which the investment in the QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for at least 5 years, there is a 10% exclusion of the deferred gain. If held for at least 7 years, the 10% exclusion becomes 15%.”
- If the investor holds the investment in the QOF for at least 10 years, the investor is eligible for an adjustment in the basis of the QOF investment to its fair market value on the date that the QOF investment is sold or exchanged. As a result of this basis adjustment, the appreciation in the QOF investment is never taxed. A similar rule applies to exclude the QOF investor’s share of gain and loss from sales of QOF assets.”
You can set up a QOZ — vehicles structured as either a partnership or corporation for the purpose of investing in an OZ census tract, whether in real estate or directly in businesses through equity — through the IRS or investing in an already existing fund. The fund requires investors to hold at least 90 percent of assets in that QOZ area. Most investment experts recommend only experienced investors set up their own QOZ due to the risk and complexity. However, you can still get the tax benefits by investing in an existing fund.
Tax benefits aside, you still need to make smart investment decisions
Like any investment, investing in QOZs carries risk. That means you need to carefully research the qualified opportunity fund you’re investing in, especially since they’re not rated by fund rating agencies. Your best course of action is to get familiar with the management, investment strategy, and projected returns and decide if it’s right for you.
Investing that’s right for you
No two people are exactly the same, so investment needs may vary. It’s possible to buy a residential house in a QOZ via a QOF as a way to diversify your investment portfolio and offset capital gains taxes. But it’s not a typical flip scenario because you’ll need to hold the property to realize the tax benefits. You’ll also need to invest in the property to qualify. As the investor, you’ll have 30 months after closing to double the property’s adjusted value (not counting land). A $100,000 home on land valued at $25,000 would need to see an additional $100,000 in investment to improve the house, for instance.
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