What Are Opportunity Zones—and Why Should Real Estate Investors Care?

by | BiggerPockets.com

“Qualified Opportunity Zones” are creating quite a buzz lately. And for good reason! There’s major profit potential for real estate investors looking to take advantage of the capital gains tax credits that came along with the Tax Cuts and Jobs Act of 2017.

In essence, the Opportunity Zones tax bill introduced incentives to invest in the development of designated low-income areas throughout the country. The tax benefits are substantial, to be sure. But unsurprisingly, the ins and outs of this legislation are a bit difficult to digest.

Here are the basics.

A Beginners Guide to Qualified Opportunity Zones

Q: What are Qualified Opportunity Zones?

A: Qualified Opportunity Zones (QOZ) are designated areas that provide tax advantages for real estate investors.

Q: Who came up with this tax advantage?  

A: Believe it or not, Sean Parker—the founder of Napster and former president of Facebook—is responsible. The tech billionaire was seeking a solution to investor cash sitting on the sidelines, cash that he believed could otherwise be invested in underdeveloped areas. He worked with senators to introduce and pass the legislation in the Tax Cut and Jobs Act of 2017.

Related: Tax Reform Update: A New Way to Reduce Taxes on Rental Income

calculator with less tax and more tax buttons

Q: When are these tax benefits available?  

A: They become available when an investment is sold, and the gain realized is invested in a QOZ. Unlike a 1031 Exchange, the investment is not limited to a real estate for real estate exchange. The gains could be from the sale of a business, stocks, bonds, or any investment with taxable gains.

It should also be noted, there is no requirement to reinvest the entire proceeds of the sale. You could potentially pocket cash and still defer all the gains by reinvesting only the gain portion of the proceeds.

Even better, depending on the amount of time you stay invested in the QOZ, the tax on the deferred gain could be reduced by up to 15 percent, and the new investment could be entirely tax-free at disposition! Plus, you have 180 days from the time of your investment sale to reinvest in a QOZ, giving you time to make that decision.

Q: Why should a QOZ interest me?  

A: A QOZ allows you or your investors to exit a current investment with gains and defer capital gains taxes, resulting in potentially massive savings. If you own land or property in a QOZ, it may be worth more than you think.

Q: How do I take advantage?  

A: Benefiting from a QOZ is easier than you might think. Simply sell an investment that has appreciated in value, and invest the gain in value into a QOZ.  

Related: IRS Code Section 199A: How the New 20% Pass-Through Deduction Affects Investors

Q: Where do I find Qualified Opportunity Zones?

The U.S. Department of Treasury, supported by the Community Development Financial Institutions Fund (CDFI Fund), has published both a list of Qualified Opportunity Zones and a map of all designated QOZs online.

Q: Where is the best place to find more information about Qualified Opportunity Zones?

The IRS has published an Opportunity Zones frequently asked questions on its website.

home framing during home construction against cloudy sky

Q: How do Opportunity Zones work?

Here’s an example of how to take advantage of these economic opportunity zones and beat “the taxman.”

John has successfully navigated the long and winding road of the lawn maintenance business. He started his company from scratch, so his original basis in his business was $0. After working “eight days a week” and achieving a certain level of success with his company, he sells it to Paul for $1,000,000.

Great news for John, right?!

Now, I don’t want to spoil the party, but John’s $1,000,000 return on the sale of his business means he has to write a check for $260,000 to the government to pay his capital gains taxes.

The euphoria John felt about selling his company quickly turns to frustration, as his tax reality settles in. He turns to his tax accountant, George, for help.

George tells him about Qualified Opportunity Zones.  

John calls a real estate investment buddy named Ringo. Ringo finds John a qualified opportunity. John buys the real estate.

Below are John’s options and the corresponding tax consequences, depending on how long he holds the investment:

  • If John holds the investment for five years, he would defer the capital gain of $260,000 until the asset is sold. John would then get a 10% discount on his gain for investing in a QOZ. This leaves John owing $234,000 instead of $260,000, and he is able to defer the gain for five years.  
  • If he holds for seven years, the discount on his gain would be 15%. He would only owe $221,000.
  • And, most impressively, if John holds the investment for 10 years in a QOZ, he would pay ZERO tax on any gains on appreciation from real estate investments in the QOZ.

Let’s say it plays out like this. John invested $1,000,000 into a Qualified Opportunity Zone. He holds it for 10 years, and sells it for $2,000,000.

John defers tax on the original investment until the time of sale and receives up to a 15 percent discount at that time. Plus, now he owes zero capital gains on the qualified investment portion of the sale, saving him $299,000 in capital gains taxes. The reason? It’s simply because he invested in a Qualified Opportunity Zone. AMAZING!

If you’re still reading this, you’re probably intrigued and have more questions. While this is a quick overview of the program, I’ve also included some helpful links below. If you have questions, feel free to reach out to me directly or comment below. Be sure to tune in next week for “The Flash Guide to Setting up a Qualified Opportunity Zone Fund.”

Intrigued? Do you have more questions? 

Reach out in a comment below. 

About Author

Andrew Propst

Andrew Propst has over 18 years of experience both in residential and commercial real estate management. Currently Andy is the CEO of HomeRiver Group (the parent company of HomeRiver Boise) and a Business Developer for HomeRiver Boise, a Certified Residential Management Company (CRMC®), in Boise, Idaho. Andrew has illustrated throughout his career his resolute commitment to delivering first-class results for clients, as well as consistently improving efficiencies and operations across his companies. Industry knowledge and a keen focus on technology has been a major priority for Andy. He has obtained four of the leading industry designations: Certified Property Manager® (CPM®) from the Institute of Real Estate Management (IREM®), Master Property Manager ® (MPM®) Residential Management Professional ® (RMP®), both from the National Association of Residential Property Managers ® NARPM®, and Certified Commercial Investment Member (CCIM®) from the CCIM Institute. Volunteerism has been a major focus and joy for Andy, from service on the National Board of Directors of NARPM® for six years as a Regional Vice President, to National Treasurer, National President-Elect, and then his election as President of The National Association of Residential Property Managers (NARPM®) in 2015. Currently, Andy serves as immediate Past President for NARPM® and continues to offer ongoing counsel and insight to the Board of Directors of NARPM®, using his extensive knowledge and experience within the industry. Andy has also had the privilege of serving on other local and national real estate boards. Andy also took a recent swing at Hollywood. As the Associate Producer of the Saratov Approach, Andy helped fund, write, promote, and deliver a national theatrical release of a full-length motion imageture that won multiple awards and returned an Internal Rate of Return (IRR) to its investors of more than 1000%. The feature was based on the true story of Andy and his missionary companion, Travis R. Tuttle, and their dramatic experience of being kidnapped and held for ransom by the Russian Mafia in March of 1998. Andy also wrote and help produce, The Story Behind The Saratov Approach: A Fireside Event in 2013, which is now available on DVD, Blu-ray, and Netflix, along with the “Saratov Approach.” As well as his commitment to his business interests and wide real estate pursuits, Andy’s family is #1 in his life. Married to his beautiful wife, Shonda Propst, for 17 years, Andy and Shonda adopted their first son, Samuel Propst, in 2008. Further, the Propst family welcomed another new addition with their adoption of Brooklyn in 2011. Originally from Oregon and now proud to call Idaho home, Andy is also bilingual, being a fluent speaker of Russian, alongside English. HomeRiver Group HomeRiver-Boise

14 Comments

  1. Mary Ann Aulbur

    I did check into this opportunity. The neighborhood was very low income. Too many people wandering the area after dark. Reputation for housing problem people.

    It might be ok if you bought the whole block or two, but do not think it would appreciate much in value. Any property bought would have to be guarded or reinforced to prevent damage. There are some who do well in these areas, but I will pass.

    • Morgan Goldstein

      Hey Mary Ann! The areas inside of opportunity zone are typically dense with low income families and affordable housing. The idea is to incentivize investors to help turn these areas around. They’ve been determined by the census tracts and there are many of them, South Carolina alone has 153!

  2. Morgan Goldstein

    I’m not trying to stir the pot but this article simply doesn’t cover nearly enough about the new OZ plans. Nowhere does the article cover the requirement of “substantial improvement” that is required to get the tax benefit, or the requirement to put your capital gains that you want to purchase a property with into a Qualified Opportunity Fund. I understand that this is a beginners article, but in a forum where the livelihood of many members is real estate investing, it’s best to give the full picture or no picture at all. If anyone is interested in finding out more about opportunity zones and the way they function, their purpose, or how to get involved with investing into one, please feel free to contact me!

  3. Estelle Angelinas

    The city where we’re planning on investing has OZ. Unfortunately we don’t qualify for the tax credits, but lots of affordable housing.. Plus, the city itself has initiated its own program, where they buy houses that have been tax foreclosed, bring them up to code and sell them to first time homeowners. This has brought the property values up and there has been a lot of appreciation. I feel, that as new investors, a good way to start is in an OZ. Sort of resilient investing…. help improve the community and make money.

  4. christian funicelli

    As already stated in the comments, the substantial improvement IS the purchase price. If John purchases that property for $1m; he then has to meet or surpass $1m of additional investment for the improvement of the property. This also has to happen within a certain time frame; at this time the rules are yet to be clear, but it makes it a very tenacious process that NEEDS expert help from start (before Johns business is even sold) to finish! Nonetheless a great opportunity for those who capitalize.

    – In VERY short lol

    • Gaurav Mehta

      @Christian: I maybe wrong here about the substantial improvement here. However, the substantial improvement has to be = Purchase Price – Value of Land. That’s what I have acquired by talking to a CPA. In some places like Bay Area, the value of land is very high.

  5. Mark Knowlden

    Yes, as with most Government programs, there are many details to understand prior to moving forward. But this Opportunity Zone (OZ) incentive is being developed to limit the complexity and stimulate private investment in challenging communities. The IRS is remaining surprisingly flexible as they finalize the rules.

    OZ is providing truly unique tax-saving ‘opportunities’ for equity investors with capital gains proceeds, and will offer property owners, developers and business entrepreneurs new ways to leverage the potential of previously un-tapped $ billions.

    There are 8,700 Qualified Opportunity Zones in the U.S. Undoubtedly, most of the zones will only offer small opportunities, but a few will present giant opportunities. It’s certainly of value for any real estate (or business) investor/developer to gain a general understanding of how to benefit from this program.

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