Real Estate Opportunity Zones - What are they?
What You Need to Know About Opportunity Zone Tax Incentives
In the last days of 2017, the US Congress passed the Tax Cuts and Jobs Act, or TCJA. This legislation created new real estate investment models, Qualified Opportunity Zones and Opportunity Funds. These models offer significant capital gains oriented tax incentives for savvy RE investors.
The Opportunity Zone program promotes investment to help develop low-income neighborhoods across the United States. The program offers investors federal tax advantages that you can only obtain through the OZ program. To invest in an Opportunity Zone, investors deposit capital into a qualified Opportunity Fund. The 2017 TCJA provisions allow the investor to reduce and defer their capital gains tax burden from any investments in qualified OZ Funds.
Before we get into the nitty-gritty details regarding tax incentives, it is crucial that you have a clear understanding of what Opportunity Zones are.
What Are Opportunity Zones?
Opportunity Zones are low-income areas designated by the governor of a state and verified by the US Treasury. These regions have historically lagged behind the rest of the country in economic development, and this program seeks to use market mechanisms and private investment to spur growth in these areas. Investors that wish to benefit from Opportunity Zone tax benefits must invest in an "Opportunity Zone Fund."
What Are Opportunity Zone Funds?
Opportunity Zone Funds, or OZ Funds, are investment vehicles that intend to invest ninety percent or more of its holdings into real property, businesses, or partnership interests within a qualified OZ. The capital investments in Opportunity Zones must be oriented towards community growth. For example, a fund might invest in a building renewal project, or an effort to bring financial services to an underbanked area.
In order to entice investors to deploy capital in economically troubled areas, these funds are given capital gains tax incentives. These benefits give investors the ability to save investment capital in the short-term as well as pay the federal government less money from their long-term returns.
Typically, when an investor sells an asset that has appreciated, like stocks, real estate, or mutual funds, they realize a capital gain. This triggers a tax event where the investor must pay a certain percentage of their profit in taxes. You can minimize your tax burden significantly by reinvesting your realized capital gain into an OZ
Where Are Opportunity Zone Neighborhoods?
OZ Funds can invest in any census tract that has been designated by the US Treasury as an OZ Fund. These areas are selected by the governor of a state and later verified as a qualified OZ domain. You can find OZ funds in big cities like NYC and LA, as well as rural areas- the main determiner is economic growth and direct capital investment. Areas with a lack of investment are more likely to qualify for OZ status.
Specific OZ Fund Tax Incentives
-When you move realized capital gains into a designated OZ Fund within a 180 day period of the asset sale you can defer paying any capital gains taxes until Dec 31, 2026, or when you sell your investment, whichever comes first. Delaying your tax liability gives you the ability to put more capital in play for an extended period. Instead of paying taxes, you can invest that money into new projects to earn increased returns.
-If you hold your OZ Fund investment for a five year period prior to Dec 31, 2026, you can reduce your capital gains tax liability by ten percent via a step-up in basis. If you extend your holding period by another two years you can reduce your deferred capital gains liability by an additional five percent. Holding an OZ Fund investment for seven years before the December 2026 end date can allow you to reduce your tax liability on deferred capital gains by a total of fifteen percent.
-Holding your OZ Fund investment for an additional three years past the end date, for a total of ten years, will reduce your capital gains taxes or any appreciation from your original OZ Fund investment to zero. This zero dollar tax bill is due to the fact that OZ Funds gains qualify for permanent exclusion from capital gains taxes as long as you hold the investment for ten years.
Opportunity Zone Funds: The Big Picture
The capital gains tax incentives give OZ Funds the potential to earn investors much better returns than with traditional investments- especially if you are in it for the long haul, for ten or more years. The ability to defer and use your capital gains to grow your portfolio is desirable, and investing in up and coming markets may bear its own rewards. To learn more about OZ Funds and how you can leverage them check out our real estate investment library.