Opportunity Zones Research

34 Replies

Greetings all.  After seeing 'Opportunity Zones' mentioned in a news article last week, I have it on my to-do list to research the landscape for these.  I will be updating this thread as I learn relevant items.  Please weigh in yourself with any additional insight, experience, or perspective that you think might help the community here.

To start, this is where I'm starting my reading/research:

https://www.irs.gov/newsroom/opportunity-zones-fre...

https://www.accountingtoday.com/opinion/opportunit...

Looking forward to a discussion.  Looks like at first glance it's intent is to serve as a market driven investment vehicle that focuses on certain areas that are likely struggling in the economic value/equity arena (sometimes these areas are the best opportunities but obviously one needs to be careful).

Again at first glance I'm wondering if opportunities exist for those prepared to start a fund and execute (flip, rent, etc) properties within these zones, but also it appears intent is for these funds/investment products to exist for more passive investors.  Will update more as I learn more...

I just sent this email to the Secretary of State here in Iowa.  We will see what comes back.  I'd be curious of where the authority to designate these zones rests in other states, some timeline expectations data points, etc.  Also I will be very curious about early data points on if this is successful in attracting capital to certain areas (will be an early indicator of possible opportunities for appreciation)!

For those of you who want a broader analysis of this initiative that just the tax benefits, check out this article.

https://nextcity.org/features/view/will-this-new-i...

I am surprised by some of the areas designated as OZONES by Colorado's governor. In Denver, some OZONES are very close to the city center. 

Another article with a nice summary:

WHAT ARE THE INCENTIVES THAT ENCOURAGE LONG-TERM INVESTMENT IN LOW INCOME COMMUNITIES? The Opportunity Zones program offers investors the following incentives for putting their capital to work in low-income communities:

  • A temporary tax deferral for capital gains reinvested in an Opportunity Fund. The deferred gain must be recognized on the earlier of the date on which the opportunity zone investment is sold or December 31, 2026.
  • A step-up in basis for capital gains reinvested in an Opportunity Fund. The basis of the original investment is increased by 10% if the investment in the qualified opportunity zone fund is held by the taxpayer for at least 5 years, and by an additional 5% if held for at least 7 years, excluding up to 15% of the original gain from taxation.
  • A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in a qualified opportunity zone fund, if the investment is held for at least 10 years. (Note: this exclusion applies to the gains accrued from an investment in an Opportunity Fund, not the original gains).

@Rodolfo Canon

Thanks Rodolfo.  I have found some more resources.

https://www.iowaeconomicdevelopment.com/opportunit...

This appears to be a map of the nominated opportunity zones in Iowa.  I'm guessing each state has their own method of sharing what's been nominated.

I'm in Des Moines and it appears there are a couple pockets of nominated areas (Drake area and what appears to be around Valley Junction in West Des Moines which surprises me):

I am also noticing that there's some great info on both of these youtube videos/websites:

https://eig.org/dci

https://www.youtube.com/watch?v=gmn19vSE-V4

If I'm reading this right there are no capital gains at all if owned for more than 10 years.  Pretty nice

Note to all that the map I posted above for DSM I do not believe to be accurate.  There are other filters to apply but I'm going to wait for clarification from a contact at the Iowa Economic Development Authority on where everything is in the process.  Looks at first glance that there were applications submitted for designated areas that encompass a lot more than what is shown above. 

According to my contact at the Iowa Economic Development Center, the US Treasury has made their selections of the 'Qualified Opportunity Zones' nationally.  I can't speak for 100% certainty that this has been completed everywhere, but I do see on this map that it seems pretty comprehensive.

https://www.cims.cdfifund.gov/preparation/?config=...

For those DSM specific investors, here are the areas that made the cut:

Seems like a good program and I'm hopeful it may help.  I'm just scratching my head as to the selection in Des Moines, with regards to it being based on need.  The Valley Junction area tends to be business heavy but a more well-to-do area with very good schools, comparatively.  The Drake University area is one of those areas where it could go either way.  I've heard many anecdotes about investment, but also just as many about drugs/crime in that area, as well.  I was surprised mainly that more pockets closer to downtown were not selected, especially given recent data available on prospects for children growing up in poor areas to 'ascend' out of poverty...

https://www.nytimes.com/2018/10/01/upshot/maps-neighborhoods-shape-child-poverty.html?action=click&module=Top%20Stories&pgtype=Homepage

Anyways, would be curious to hear others' input on the selection areas to see if this was effective (beyond just allowing folks like us to just get around capital gains).

Hi @Jim Goebel , i’m from DSM lived here for 10+ yrs and i wouldnt disagree with your comments about the areas. My one point would be that both of those areas have the highest potential to become “the next” place to be. There are a few other areas (east of state capital) or the east side of MLK all the way to ne 14th, but those areas are not close to the tipping point yet in my eyes. Also, valleu junction does have some business but there is a LOT of potential there to get a house at the lowest price in WDM school district. Just some thoughts...

Hi guys,

We are starting to do this in Kansas City, specifically Independence, we are lucky to have a HUGE OZone designation here and a great CPA and Tax Accountant to guide us in setting up the fund(s) and we have some great off market properties we are working on! I will be following your posts, and can add in some of our CPA's info if you would like. :)

Very interesting information!  Following the thread, thanks for doing the DSM based research and posting it.  Looking forward to more input from the local community.

Drake does not "surprise" me as being targeted.  I would of expected east of MLK to 2nd Ave and North of University up to the Hickman to be included (Mondamin Presidential, River Bend, Evelynn Davis Park) with exclusions for Chautauqua Park and Historic River Bend, not to say they couldn't use a boost but... maybe less so than the immediate surrounding.

I can see Valley Junction being inside the zone.  While comparative to Drake and the above neighborhoods it appears significantly more stable, by public persona, there is a fairly default rate there.  Additionally, there is a lot of deferred maintenance and deteriorated property grades.  That said, in my opinion it is more likely to stabilize naturally than the above named neighborhoods. 

Either way, great opportunity to defer some capital gains and/or eliminate them long term!

@Taylor Marvin  

@Terry Mclain

@Jahbari McLennan

Yes, that's my understanding.  It's for equity investors - and the capital gains advantages kick in where you own an asset for 10 years.  You need to click on the links to see the map overlay for your location.  The location selections have been finalized everywhere in the US, though - is my understanding.

My guess is that you will also need to inform either your customers, and get a CPA involved as it doesn't seem like this knowledge of the program(s) has gotten out completely, yet.  So there may be a learning curve/awareness hurdle to overcome.

Further guidance from US Dept of Treasury released on Friday.

https://home.treasury.gov/news/press-releases/sm53...

link to PDF at bottom.......

In skimming it, here's some notes that are not 'CPA proofed' but what I'm gathering:

  • Seems that a maximum committed time is communicated - in other words, 10 years is the minimum holding time to get the preferrable (0%) capital gains treatment during a sale event - but there's guidance now to indicate that 20 1/2 years is the total time that the treatment (at a minimum) will occur, so as I'm guessing to prevent a future change and not encourage a situation where everyone wants to sell their assets/businesses, etc right when the 10 years kicks in
  • Seems there may only be a 6 month window to place funds / earmark funds as available for an opportunity fund.  Similar to a 1031 it seems, there's a process in place for putting the funds somewhere, and then there's a time limit to selecting and allocating the funds somewhere.  Need to learn more about this......
  • Seems that other tax breaks may exist for businesses that happen to have their property within an opportunity zone, or are looking to locate there.  Not sure on the specifics here but as long as 70% of property sits within opp zone, seems that tax advantages apply to the business beyond just the real estate
  • If I'm reading this right, let's say you sell something you already own - which would initiate a capital gains event - you get to defer having to pay those capital gains until 2026 if you reinvest the funds in an opportunity zone
  • Seems that the tax advantages fall to both the owner and a tenant (for instance let's say a business is leasing in this area and building equity in their business).  So this isn't specific to the real estate or the owner of real estate
  • Seems as though there are rules/guidance (in development) regarding amount of cash held (ie working capital) for a business within an opportunity zone.  Theory being that let's say I own 3 businesses, one having a physical location within opportunity zone.  I could in theory transfer funds into bank account A if it is in opp zone, with intent being to maximize tax advantages.  Will need to learn more here as certainly it seems opportunities exist to maximize tax benefit

Hello All, I am a CPA that has been working with opportunity zone since they came out and wanted to pass along some information and thoughts I had on them. 

1. Must roll capital gains into a Qualified Opportunity Fund (QOF) and hold for 10 years to get the permanent exclusion benefit. Your original capital gain will be deferred until December 31, 2026 in this case and you'll only pay on 85% of the original amount. (Example - $100,000 capital gain rolled into a QOF, pay tax on $85,000 capital gain on December 31, 2026 if your investment in the QOF is still held at that point). Good time value of money savings here, but the big one is the permanent exclusion after 10 years. 

2. You can roll your investment from one QOF to another and still maintain compliance with the 10-year rule as long as you dispose of your entire interest in the QOF and roll it into another qualifying QOF within 180 days. 

3. You must substantially improve the property. This means doubling the adjusted basis within any 30-month time period. Adjusted basis does not include land value. Example - buy an old apartment building for $1,000,000 ($400,000 allocated to land, $600,000 allocated to building). You then need to increase your basis by $600,000 to "substantially improve" the property. 

4. In concert with the above substantial improvement stipulation, you can benefit by substantially improving the property at the same time 100% bonus depreciation is available (until January 1, 2023). Below is a visual chart depicting this, from an article I wrote for my company's website on the topic ( https://www.withum.com/resources/substantial-impro... )

Note the 30-month substantial improvement doesn't have to be where it is shown below, its stipulated in the Internal Revenue Code as being any 30 month period. 

5. 90% rule - a QOF must hold 90% of its assets in qualifying opportunity zone property. This can be stock, partnership interest, or business property. This will be measured semi-annually to ensure compliance. Example - QOF has $1,000,000 of capital gains rolled into it. It must have $900,000 tied up in opportunity zone property within 180 days. Limited to a max of just $100,000 cash on hand. 

6. 70% Substantially All Requirement - A qualified opportunity zone business must have 70% of its tangible property be QO Zone Business Property. 

7. Combine the two and you can have additional cash on hand - an LLC (the qualified opportunity zone business) would invest in the real estate directly and the QOF would own a partnership interest in the LLC. 90% x 70% = 63% invested into real estate and more room for cash on hand earmarked for future improvements / development. Much more flexibility here than the QOF investing directly into the real estate.

8. 31 month rule - working capital safe harbor for cash on hand. If you have a written schedule (and eventually spend cash according to the schedule) you can have cash on hand that doesn't count against you for the above 90% and 70% rules for 31 months. This is very favorable for putting cash aside that qualifies for the permanent exclusion and will be used to substantially improve property a year or two down the line. 

9. Partners in a partnership - if your partnership has a capital gain and does not elect to defer it at the partnership level, each individual partner can elect to defer their respective portion of the capital gain into a QOF. In this case, they may have additional time over and above the 180 day rule to roll the gain amount into a QOF. They'd have 180 days on the first day the partnership would be required to pick up the gain as taxable income. So for example, calendar year partnership with four partners, they have a capital gain of $400,000 on May of 2018. The first day it would be recognized by the partnership would be January 1, 2019 - so the individual partners would have until June 30, 2019 to roll their respective $100,000 capital gains into a QOF. This is much more advantageous than the otherwise noted rule for individuals to roll over the gain amounts by November 2018 (180 months from the capital gain). 

Please feel free to reach out or respond if you have any questions - I know this can be a lot, but I am excited to share my knowledge of the program with others, continue to learn, and help out in any way I can. 

I've been trying to think how the QOF would work with the BRRR method. Are you able to refinance your money out, or do you have to leave the gain invested in the QOF?

For example I have capital gain of $100k which I use to buy a property for $50k and rehab it with the other $50k. ARV is $140k and I take a mortgage out for $100k. Is the deferred gain then equal to my equity position?

This is from pg. 8/74 from the regs. (https://www.irs.gov/pub/irs-drop/reg-115420-18.pdf

C. Investments in a QOF The proposed regulations clarify that, to qualify under section 1400Z-2(a)(1)(A), (that is, to be an eligible interest in a QOF), an investment in the QOF must be an equity interest in the QOF, including preferred stock or a partnership interest with special allocations. Thus, an eligible interest cannot be a debt instrument within the meaning of section 1275(a)(1) and §1.1275-1(d). Provided that the eligible taxpayer is the owner of the equity interest for Federal income tax purposes, status as an eligible interest is not impaired by the taxpayer’s use of the interest as collateral for a loan, whether a purchase-money borrowing or otherwise. The proposed regulations also clarify that deemed contributions of money under section 752(a) do not result in the creation of an investment in a QOF.

I presently own a 3-plex in opportunity zone (owned by LLC). I have about $150,000 in LTG this year. I plan to set up an QOF.

Will I be able to to transfer ownership of the 3-plex LLC to QOF (3-plex has about $55,000 left in depreciation)?

Spend $95,000 on rehab.....

Thanks

@Tim Butters You are able to refinance your money out. However, since refinancing is not a taxable event, it wouldn't exactly work for the BRRRR method in a QOF. But there is a way around this (kind of). You would correctly be able to defer your first capital gain and you'd meet the substantial improvement provision in your example. Then, you are allowed to refinance a QOF investment. Your deferred gain is still $100,000.

However, when you go to buy the second property with the cash from the refinance is where that second purchase would not qualify as a qualified opportunity zone property since it was not purchased with capital gains (this is how the regulations read now, still in a comment period before they are finalized). 

What you can do is sell your first QOF investment (must dispose of the entire interest) and then if you roll that full amount into a new QOF investment within 6 months, that will work. You can then defer the second capital gain. As long as you follow these rules, you can keep doing this. 

Going along with your prior example, you invested your initial $100K capital gain into a QOF, met the provisions for substantial improvement, and then sold the property for $140,000.  You'd then have to roll the full initial deferral amount ($100K and then make a second deferral election for the $40K amount) into a new QOF investment (a bigger property perhaps). You can keep doing this as long as you get the funds rolled into the new investment within 180 days, and then you would still meet the requirements to keep deferring your initial capital gains ($140,000) until the later of December 31, 2026 or the date you sell and if you kept your money in a qualified opportunity fund for 10 years, you'd still get the permanent exclusion on the ultimate sale after 10 years. 

@Rodney Blackwell To qualify for the benefits of an opportunity zone property, the property must have been purchased after December 31, 2017. Additionally, property must be purchased from an "unrelated party". So, you cannot purchase property back from yourself under a different LLC that you already own and receive the benefits of opportunity zones.

There is a slight workaround this, if you wanted to roll your LTCG amount (can roll either the full thing or part of it) into a QOF with other investors. If you are less than a 20% owner in the QOF, you would not be a related party and it appears you could purchase the property then and have it qualify as a QOF investment. (You can then take the capital gain from this sale of the 3-plex and roll it into a different QOF investment). Then, you would need to go through the process of "substantially improving" the 3-plex property by doubling the adjusted basis in the building. There are more rules around this and it can get pretty complex, so I'd definitely speak to a CPA if this is the ultimate route you decide to take. The other option would be to sell the 3-plex when you are done with it and then use that capital gain (plus your other $150,000 capital gain if you wanted) to roll into a QOF that you invest in another property in an opportunity zone. 

Originally posted by @Dalton DesRoches :

@Tim Butters You are able to refinance your money out. However, since refinancing is not a taxable event, it wouldn't exactly work for the BRRRR method in a QOF. But there is a way around this (kind of). You would correctly be able to defer your first capital gain and you'd meet the substantial improvement provision in your example. Then, you are allowed to refinance a QOF investment. Your deferred gain is still $100,000.

However, when you go to buy the second property with the cash from the refinance is where that second purchase would not qualify as a qualified opportunity zone property since it was not purchased with capital gains (this is how the regulations read now, still in a comment period before they are finalized). 

What you can do is sell your first QOF investment (must dispose of the entire interest) and then if you roll that full amount into a new QOF investment within 6 months, that will work. You can then defer the second capital gain. As long as you follow these rules, you can keep doing this. 

Going along with your prior example, you invested your initial $100K capital gain into a QOF, met the provisions for substantial improvement, and then sold the property for $140,000.  You'd then have to roll the full initial deferral amount ($100K and then make a second deferral election for the $40K amount) into a new QOF investment (a bigger property perhaps). You can keep doing this as long as you get the funds rolled into the new investment within 180 days, and then you would still meet the requirements to keep deferring your initial capital gains ($140,000) until the later of December 31, 2026 or the date you sell and if you kept your money in a qualified opportunity fund for 10 years, you'd still get the permanent exclusion on the ultimate sale after 10 years. 

 I guess my question is in this scenario, what is deferred gain if the $100k is distributed from QOF? Do you think it's $40k, $100k or $0. 

Another thing I'm thinking about in your scenario above about selling. If you are making substantial improvements with the intent to sell, won't that kill that capital gain element? I just want to hash this out before flippers start thinking they can use a QOF to defer all their gains.

@Tim Butters If you refinance out $100,000 - your deferred gain is still just the $100K you rolled in initially. That deferred gain won't be recognized until Dec 31, 2026 or when you sell the investment (whichever is sooner). A refinance is not a taxable event and you would still have your original equity position in the property. You can do a refinance, but can't use the proceeds to invest in a new property and get the OZ benefits. 

The substantial improvements have no effect on the amount of capital gain deferred. That amount is determined when you make the initial deferral. In the example where you roll $100K in and use $50 to purchase and $50 to rehab, the deferred gain amount would still be the $100K that you did not pay capital gains tax on when you rolled it into a QOF. That will be the amount deferred until December 31, 2016 or when you sell the investment (whichever is sooner). 

Hope this helps. 

To clarify also, the substantial improvement provision would make it pretty difficult to achieve this in most markets with house flipping I would imagine. For example, say you had a $300K house and let's say 70% ($210,000) of that purchase price is allocated to building and 30% ($90,000) to land.  You'd then have to put $210,000 of rehab into that house flip to meet the substantial improvement provision and qualify for the permanent opportunity zone exclusion (meaning no tax due when you ultimately sell your opportunity zone investment if held for 10 years). 

Opportunity zones are much easier to do with commercial properties and development rather than a single family flip. The numbers may still work with a single family flip, but be cautious of the substantial improvement provision. 

Originally posted by @Dalton DesRoches :

To clarify also, the substantial improvement provision would make it pretty difficult to achieve this in most markets with house flipping I would imagine. For example, say you had a $300K house and let's say 70% ($210,000) of that purchase price is allocated to building and 30% ($90,000) to land.  You'd then have to put $210,000 of rehab into that house flip to meet the substantial improvement provision and qualify for the permanent opportunity zone exclusion (meaning no tax due when you ultimately sell your opportunity zone investment if held for 10 years). 

Opportunity zones are much easier to do with commercial properties and development rather than a single family flip. The numbers may still work with a single family flip, but be cautious of the substantial improvement provision. 

 I haven't read the full new proposed reg, but by saying no tax due,  are you including depreciation recapture?