Opportunity Zones - Yay or Nay?

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Opportunity Zones - Yay or Nay?

Max Ball
Specialist · San Francisco · Member since 2018 · 29 posts · 8 votes

Opportunity Zones are a new community development program established by Congress in the Tax Cuts and Jobs Act of 2017 to encourage long-term investments in low-income urban and rural communities nationwide.

The program was created by Sean Parker, founder of Napster and President at Facebook. Opportunity Zones are all the rage in Silicon Valley because of the massive tax breaks.

Do you think Opportunity Zones will benefit residents of low-income communities? Or will they speed up gentrification and increase displacement?

Look forward to your replies!!

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Russell BrazilBusiness Member
Moderator
Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
7y

You shouldnt let the tail wag the dog.  If you happen to invest in an opportunity zone, by all means take advantage of the tax benefits of doing so. But to target an area based on that would be folly.  These are locations that almost by definition will be high risk areas.  You are being incentived to take a higher risk with your capital.  

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  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y

    You shouldnt let the tail wag the dog.  If you happen to invest in an opportunity zone, by all means take advantage of the tax benefits of doing so. But to target an area based on that would be folly.  These are locations that almost by definition will be high risk areas.  You are being incentived to take a higher risk with your capital.  

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  • Jimmy Klein
    Investor · Houston, TX · Member since 2013 · 195 posts · 102 votes
    7y

    I still don't fully understand the opportunity zones. Do you have to do new development or can someone just acquire a property there and hold it? 

    2Reply
  • Max Ball
    OP
    Specialist · San Francisco · Member since 2018 · 29 posts · 8 votes
    7y

    @Russell Brazil Thanks for your feedback, Russell. The issue is, to reap any tax benefits, you would have to invest in an OZ via a Qualified Opportunity Fund. I do agree these are high risk areas, but in my opinion the reward is even more substantial because it's essentially inorganic gentrification which could drive up prices exponentially.

    0Reply
  • Max Ball
    OP
    Specialist · San Francisco · Member since 2018 · 29 posts · 8 votes
    7y

    @Jimmy Klein It's both. The biggest question still up in the air is: Do you have to hold a single property in an OZ via an Opportunity Fund for 10 years to receive 100% deferred capital gains on appreciation, OR can you essentially 1031 exchange every 2-3 years across multiple opportunity zones and still get the 100% deferred capital gains. I'm hoping for the latter.

    0Reply
  • Jimmy Klein
    Investor · Houston, TX · Member since 2013 · 195 posts · 102 votes
    7y

    @Max Ball

    So basically someone can just buy a property in an opportunity zone and do nothing as far as improvements and still get the tax benefits? Or do they have to do improvements? I am not seeing any language mentioning this. All I see is that an investment needs to be done.

    1Reply
  • Max Ball
    OP
    Specialist · San Francisco · Member since 2018 · 29 posts · 8 votes
    7y

    @Jimmy Klein From what I've read you have to spend at least the same $ amount on improvements as you did purchasing the property.

    2Reply
  • Jimmy Klein
    Investor · Houston, TX · Member since 2013 · 195 posts · 102 votes
    7y

    @Max Ball

    Ok so if I buy a $1 million property. I have to spend an additional $1 million right away or over the course of 10 years.

    1Reply
  • Max Ball
    OP
    Specialist · San Francisco · Member since 2018 · 29 posts · 8 votes
    7y

    @Jimmy Klein Just before you sell it if I'm not mistaken.

    0Reply
  • Johnny PineyroPro Member
    Golden Oak, FL · Member since 2018 · 78 posts · 25 votes
    7y

    Yay for sure.  Go to the OZ website for blocks of areas that are covered.

    1Reply
  • Lien VuongBusiness Member
    Real Estate Agent · Boston, MA · Member since 2018 · 2k+ posts · 1k+ votes
    7y

    I think it's important to clarify that you cannot just 'enter' into a fund with regular money. ONLY the funds that are being used in a tax deferment program would be eligible. For example, if you made $200,000 from a sale of a home you can select a product in the identified market and then create an LLC (required) and then specifically identify that property as your OFZ property and ''park' your money there.

    Please see what I've attached as the guidelines to the timeframe of how much they will forgive your deferment. To maximize on the deferment and pay 0%, it would have to be 10 years. 

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  • Jeffrey Holst
    Investor · Chattanooga, TN · Member since 2016 · 676 posts · 543 votes
    7y
    @Max Ball pretty sure there's a limited time in which you have to put the additional resources in like 36 months or something I don't remember exactly but it's definitely not over the 10-year period
    1Reply
  • Jeffrey Holst
    Investor · Chattanooga, TN · Member since 2016 · 676 posts · 543 votes
    7y
    @Russell Brazil I disagree the tax benefits can be substantial and can potentially make the deal significantly better. In general I agree that you shouldn't take a essentially risky investment and make it just for the tax benefits but some of these opportunities zones are in up-and-coming areas where you might want to invest anyway and if you're trying to decide between investing in an area that's up and coming in in an opportunity Zone and one that's up and coming and not in an opportunity Zone it would be crazy not to choose the one that's in the opportunity Zone particularly if you have some capital gains that you want to defer. the major benefit of opportunities on is that you can take capital gains from any investment class capital gains from a stock sale for example and use them to buy a business or real estate in an opportunity Zone provided you follow the rules and put it into an opportunity Zone fund and all that and then you can defer those games for up to 10 years but even more important part is if you do defer them for 10 years any games that you gained from the investment in the opportunity zone are 100% tax free. That's an ignoramus advantage they would be crazy to overlook.
    1Reply
  • Jeffrey Holst
    Investor · Chattanooga, TN · Member since 2016 · 676 posts · 543 votes
    7y
    Another thing about opportunity zones to keep in mind is that there's a lot of them some are in really risky areas but others are in great areas. since the rules allowed the local governments to designate opportunity zones based on the 2010 census poverty levels some of the communities were able to get opportunity zones approved in areas that quite frankly as we sit here in 2018 probably should have never been opportunity zones. I think anyone involved in real estate would be wise to pull up the opportunity zone map and look at the areas included in it and their investing zones and look for overlaps. My partner and I are under contract to buy an apartment complex and it happens to be in an opportunity Zone we didn't even know it when we went under contract for the apartment complex and some nearby a couple of other complexes that we have and this one just happens to be in an opportunity Zone doesn't even appear to be a rhyme or reason as to why it's in an opportunity Zone. that being said it's not a redevelopment project and we're not going to be able to take advantage of the tax credit because there's no way that we can put a hundred percent additional Capital into this particular project but what it did is it got us thinking there might be another property nearby that does need that kind of redevelopment and so now we're actively seeking other properties in that same area that will help us build our existing portfolio and potentially get significant capital gains tax deductions at the same time.
    3Reply
  • AJ ShepardPro Member
    Real Estate Syndicator · Portland, OR · Member since 2014 · 453 posts · 312 votes
    7y
    @Jeffrey Holst @@Max Ball I'm pretty sure there is still some guidance to come on the subject. But one point that I've heard discussed is the 100% improvement or development required is based on the existing structure, not the acquisition cost. Ie when you buy real estate portion is land, portion is improvements. Say you bought a 200k property and depending on where you bought it it may be 150k of land, and 50k of structure (improvements). In the OZ, you'd only need to put an additional 50k in construction improvement to qualify. There is a little bit of wiggle room when buying real estate to classify in taxes what portion is land and what is structure ( structures are depreciated). But in the OZ it may be beneficial to classify less structure so as to to require less capital improvements.
    3Reply
  • Jimmy Klein
    Investor · Houston, TX · Member since 2013 · 195 posts · 102 votes
    7y

    @AJ Shepard

    Thanks for the info. Makes sense that improvements should be based on actual structure value, not land. If it is true that the total value of improvements just need to happen over the life of the hold and not within the 10 year timeframe, I think OZs are quite promising. To be able to not only defer the cap gains from your initial investment, but as well as your new investment is amazing. 

    1Reply
  • Scott Krone
    Investor · Northbrook, IL · Member since 2017 · 352 posts · 295 votes
    7y

    @Jimmy Klein @Lien Vuong @Jeffrey Holst @Russell Brazil - A few items to clarify.  First, I am not a lawyer nor a CPA.  That being said, I have spent a good number of hours on the phone with the IRS discussing this program.  A few points I have taken away from those conversations:

    1.  The zones were created by the State and local authorities.  They are not necessarily "high risk" areas.  They are areas where the governing authorities wanted to encourage economic development.  They literally can ebb and flow from one street to the next in a city or region.

    2.  The zone is not the investment vehicle.  It is the Fund.  The Fund has to invest 90% of its holdings into businesses or properties in designated zones.  The investment can be in any zone.  There is a minimum investment for establishing the Fund.  Opportunity Zones have gotten the news lingo, but the key is the Opportunity Fund.

    3.  The investment into the Fund has to be from capital gains - any type of capital gains.  You have 180 from the realization of the gains to investment in the Fund.

    4. As with Self Directed IRA's a disqualified investor is a major concern for the program. You can't create a fund and then buy your own property. Let's call the Investor "A". Investor A is interested in a development by Developer "C". Investor "A" can invest in a Fund by Fund Manager "B". A invests in B, and then B invests in C. It has to be an arms length transaction. A can not directly invest in C, nor can A say they have a fund and invest in A's own property.

    Please keep in mind when I began the conversation with the IRS there were only 2 pages of tax code written at the time.  There has been more published, and the laws will continue to develop.  Is it a useful tool for real estate - 100% absolutely.  Does it fit every investment - no it does not.  However, it would be foolish to overlook it.

    4Reply
  • Matt Ward
    Specialist · San Francisco Bay Area · Member since 2018 · 221 posts · 160 votes
    7y
    @Lien Vuong Actually it’s not just the cap gain portion of your money that can be invested into a QOF, but rather you can invest both your basis and gain amounts and it would be considered a “mixed funds” investment. Only the gain portion of those funds is eligible for the favorable treatment. Tagging some others who know about this as well, but I’m happy to answer questions. Going over this topic with our real estate clients, the two main things that stand out is how favorable this is and when you look at the zoning maps, how many zones there are. @Michael Plaks @Natalie Kolodij @Brandon Hall @Nicholas Aiola
    3Reply
  • Jeffrey Holst
    Investor · Chattanooga, TN · Member since 2016 · 676 posts · 543 votes
    7y
    @Scott Krone thank you for writing a much more coherent post than my ramblings. I concur with what you said.
    1Reply
  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    7y

    @Max Ball an investment into a QOF is a security, not a direct interest in land.  You can't 1031 a security so this will not work.

    To your question - I think it can help the residents of the low-income communities as it gives an incentive for investors to build and improve properties which may be run down.  Sure, it could transform an area and due to cost push low-income people out but I don't think that is very likely.

    There has been a lot of steam on this, it can work well in certain situations (been sitting on heavily appreciated stocks and want to diversify into RE) but these are primarily low-income areas and the holding periods are long.  I don't know many RE investors who would want to commit the capital that long.

    0Reply
  • Tony Kim
    Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
    7y
    Originally posted by @Russell Brazil:

    You shouldnt let the tail wag the dog.  If you happen to invest in an opportunity zone, by all means take advantage of the tax benefits of doing so. But to target an area based on that would be folly.  These are locations that almost by definition will be high risk areas.  You are being incentived to take a higher risk with your capital.  

    I looked at some of the designated OZs near my area so I could get a point of reference for the kinds of neighborhoods that would be in play. Turns out that the multi-unit I'm currently in escrow for is  located right in the middle of an OZ between Exposition Park and MLK (for those of you familiar with the area). Also, I'm not sure how they made these designations, but some of these designated areas contain million-dollar high rise condos and several luxury class A apartments. I would hardly label these areas as low-income or needing any additional incentives for investment because there is already a ton of activity. Not complaining because this is certainly good news for me...but I have to really wonder how some of these OZs were decided.

    2Reply
  • Tony Kim
    Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
    7y
    Originally posted by @Scott Krone:

    @Jimmy Klein @Lien Vuong @Jeffrey Holst @Russell Brazil - A few items to clarify.  First, I am not a lawyer nor a CPA.  That being said, I have spent a good number of hours on the phone with the IRS discussing this program.  A few points I have taken away from those conversations:

    1.  The zones were created by the State and local authorities.  They are not necessarily "high risk" areas.  They are areas where the governing authorities wanted to encourage economic development.  They literally can ebb and flow from one street to the next in a city or region.

    2.  The zone is not the investment vehicle.  It is the Fund.  The Fund has to invest 90% of its holdings into businesses or properties in designated zones.  The investment can be in any zone.  There is a minimum investment for establishing the Fund.  Opportunity Zones have gotten the news lingo, but the key is the Opportunity Fund.

    3.  The investment into the Fund has to be from capital gains - any type of capital gains.  You have 180 from the realization of the gains to investment in the Fund.

    4. As with Self Directed IRA's a disqualified investor is a major concern for the program. You can't create a fund and then buy your own property. Let's call the Investor "A". Investor A is interested in a development by Developer "C". Investor "A" can invest in a Fund by Fund Manager "B". A invests in B, and then B invests in C. It has to be an arms length transaction. A can not directly invest in C, nor can A say they have a fund and invest in A's own property.

    Please keep in mind when I began the conversation with the IRS there were only 2 pages of tax code written at the time.  There has been more published, and the laws will continue to develop.  Is it a useful tool for real estate - 100% absolutely.  Does it fit every investment - no it does not.  However, it would be foolish to overlook it.

    For tax deferment at the state level, are we still waiting for clarification from each of the states that have income tax?  For CA residents, this would obviously play a big factor.

    Also, I assume no deferment on depreciation recapture?

    1Reply
  • Max Ball
    OP
    Specialist · San Francisco · Member since 2018 · 29 posts · 8 votes
    7y

    @Tony Kim The Opportunity Zones were decided via data from the 2010 Census so, as you mentioned, there are OZ's with million dollar condos as well as OZ's in some of the most crime ridden, lowest-income areas in the US. I know where I live in LA, There are two OZ's right next to each other: one over Skid Row, one of the lowest-income streets in the US, and one over The Arts District which has been gentrifying for the past 5 years and now has million dollar condos on every street corner.

    1Reply
  • John Nachtigall
    Santa Rosa, CA · Member since 2017 · 325 posts · 701 votes
    7y

    There are a lot of people with a lot of money convinced they are great

    https://www.chicagobusiness.com/commercial-real-es...

    100+ million in 17 hours is pretty impressive.   

    I listened to the webinar that Origin did yesterday.   My impressions

    - They think 90% of the areas are un-investable, but 10% are ok and they are in some of those areas already.  

    - They stated it was the best tax break they had ever seen.   They emphasized that the deal still needs to be sound, but this makes it significantly better.  

    - It is long term (10 years) not get in-get out investing. In the example they used it raided the IRR about 3% so 18% IRR not 15%. over 10 years that is a big difference in return.

    1Reply
  • Jameson Sullivan
    Real Estate Broker · Tacoma, WA · Member since 2016 · 545 posts · 252 votes
    7y

    We've been discussing this a lot in my office. The general consensus around here is that he opportunity zones are great opportunities for super high net worth individuals looking for good safe havens but as far as your average developer, we feel there are too many other opportunities to make money. In other words, the opportunity zones are a great way to shelter income, but not so great for actually producing capital.

    2Reply
  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    7y
    Originally posted by @Tony Kim:
     Turns out that the multi-unit I'm currently in escrow for is  located right in the middle of an OZ between Exposition Park and MLK (for those of you familiar with the area).

    Not complaining because this is certainly good news for me...but I have to really wonder how some of these OZs were decided.

    Unless you are using tax deferred funds and planning for a major improvement your tax benefits will be $0...  I think a lot of people are confused about these.  This can be a big deal but I think the usefulness is narrow.  It is likely to be used more by private equity groups and syndicators to raise capital and move it into the real estate sector.

    1Reply
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