Opportunity Zones: All The Rage

Original Post - Renat Yusufov

Opportunity Zones (“OZ”) have been one of the hottest topics in commercial real estate throughout 2018. A provision introduced and outlined in President Trump’s 2017 Tax Reform bill, the creation of OZ is intended to help low-income communities through tax incentives for investors.

Summary: Investors are allowed to defer taxes on capital gains if the capital is reinvested in opportunity zones through direct or fund investment vehicles. The investment can range from real estate development to direct investment in local business. The amount of the capital gains tax that can be deferred depends on the duration of the investment held (see timeline below) OZ are identified geographically by local and state municipalities, who are best suited to select communities that would benefit the most from capital injection.

Beneficial for:

· Low-income communities from investment injection in local businesses and real estate development.

· Investors seeking to minimize capital gains tax, from deferment / elimination of capital gains tax, depending on the hold period.

· Real Estate Developers seeking investors.

· Municipalities that have Opportunity Zones in them.

· Other parties, including lenders or local business owners, who are key stakeholders in either the community or have a financial stake in local businesses or development.

Considerations for Potential Investors:

· Investors must reinvest capital gains into a Qualified Opportunity Fund (“QOF”) or directly invest in an OZ within 180 days of realizing capital gains in order to qualify for the related deferment.

· Unlike a 1031 exchange, there is no requirement for a “like-kind” investment to be made to qualify for the tax deferral.

· The deferred gains are taxable when the OZ Investment is sold or, if earlier, on December 31, 2026. Note that if you still hold your OZ Investment on December 31, 2026, you will have phantom income (taxable income with no corresponding cash) since your deferred gains become taxable at that point. It is expected that many QOFs will coordinate some sort of tax distribution to alleviate this concern.

· Similar to REITs, a QOF has a 90% test; the QOF must have 90% of its assets invested in Qualified Opportunity Zone Property. This test is measured annually.

· Investments made in an OZ must show appreciation in value to demonstrate a value-add to the community and investor.

Assets Eligible for investment:

· Stocks in Qualified OZ corporations

· Partnership interest in a Qualified OZ partnership

· Business property or developments in a Qualified OZ

Sample Investment:

You recently sold your stock portfolio and have $100 in proceeds to invest in an OZ ($50 was your original investment in the stock portfolio and you saw a $50 long-term capital gain). Your investment in the OZ yields a 5% return annually (i.e. after 1 year, your $100 will be worth $105).

Your Investment will be accounted for as follows over the full investment period: