Opportunity Zones - Is There a Window for Reinvesting?

Tax, SDIRAs & Cost Segregation
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Opportunity Zones - Is There a Window for Reinvesting?

Mindy JensenPro Member
BiggerPockets Money Podcast Host · Longmont, CO · Member since 2014 · 7k+ posts · 10k+ votes

I just heard of this thing called Opportunity Zones. A guy I met recently has sold his rentals this year, and is getting ready to take a tax hit. I don't know enough about Opportunity Zones to speak intelligently about them, so I told him that they exist, and sent him on his researching way.

Are OZ's an option for him or is it more like a 1031 where there is a limited time window? 

Tagging @Jay Hinrichs because he knows everything. 

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Frank Jiang
Investor · San Diego, CA · Member since 2014 · 592 posts · 765 votes
8y

Here's an excellent explanation of how they work:

https://eig.org/wp-content/uploads/2018/01/Tax-Ben...

As well as a map with all of the qualified zones in CA:

http://dof.ca.gov/Forecasting/Demographics/opportu...

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    8y

    I have not looked into this in depth as I don't have anything that would qualify for this tax treatment.

    @scottmeyers knows some detail on this I believe.

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  • Mindy JensenPro Member
    OP
    BiggerPockets Money Podcast Host · Longmont, CO · Member since 2014 · 7k+ posts · 10k+ votes
    8y

    Thanks Jay. There are 4 Scott Meyers on the site, so I'm not sure which one to tag for you. Hopefully he has his name as a keyword alert.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    8y

    @Mindy Jensen, 

    Yes. He has 180 days to reinvest his gain into the zone. 

    Also, unlike 1031, he doesn’t have to reinvest the entire sale proceeds. 

    He can just invest gain and not his basis, or part of the gain (he will be taxed on part that he didn’t invest) or he can invest more than gain or proceeds by leveraging on top of this gain. 

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  • Frank Jiang
    Investor · San Diego, CA · Member since 2014 · 592 posts · 765 votes
    8y

    Here's an excellent explanation of how they work:

    https://eig.org/wp-content/uploads/2018/01/Tax-Ben...

    As well as a map with all of the qualified zones in CA:

    http://dof.ca.gov/Forecasting/Demographics/opportu...

    4Reply
  • Buckner Toney
    Rental Property Investor · Denver, CO · Member since 2018 · 21 posts · 12 votes
    8y

    Very interested in this topic. At the ICOR event this past weekend, they had the two Colorado gubernatorial candidates and a current Denver city admin that all mentioned these Opportunity Zones and them being newly designated here.

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  • Matt M.
    Realtor · Denver, CO · Member since 2013 · 2k+ posts · 1k+ votes
    8y

    There are a few threads on this. The search tool is your friend;).

    Here is a map for Colorado: https://choosecolorado.com/opportunity-zones/

    Everything isn't ironed out yet, but it should be soon. We are looking at putting a fund together to take advantage of it. 

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  • Chris LopezPro Member
    Real Estate Agent · Denver, CO · Member since 2015 · 1k+ posts · 858 votes
    8y

    @Mindy Jensen I have a bunch of back and forth emails with a few people around Denver who are active with O Zones. I'll forward them on to you.

    Reach out to @Rodolfo Canon as well. He's a Denver based developer and a commercial agent that is familiar with it.

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  • Tally Lawing
    Residential Real Estate Broker · Denver, CO · Member since 2016 · 5 posts · 2 votes
    8y

    please send me whatever info you may have as well Chris!

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  • H Patel
    North Augusta, SC · Member since 2017 · 26 posts · 1 vote
    8y

    Hello. I am very glad to come across the Opportunity Zone (OZ) topic. I am small lodging operator in North Augusta, SC. Recently, the area in which the motel sits was deemed OZ status. From my perspective, what financial tools would be available to me to utilize this status for profit? I am motivated to set this up as a long term NNN lease.

    I understand (sorta, kinda) the basics of OZ. It is a economic driver meant to ease influx of investments. Do I now reach out to investors or real estate representatives?  Can I DIY some things before involving more and more people.  Would love to banter around some ideas. Thanks y'all.

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  • Rodolfo Canon
    Commercial Real Estate Agent · Denver, CO · Member since 2018 · 109 posts · 81 votes
    8y

    Hem,

    As others have posted, the final regulations have not been posted yet. However, your situation is clear. You can create your own qualified "Opportunity Fund" and use this asset as your investment in that fund. A qualified Opportunity Fund is a privately managed investment vehicle organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property. Hold it for 10-years and sell it and avoid capital gains tax.

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  • Austin Hendrickson
    Investor · Minneapolis, MN · Member since 2016 · 139 posts · 143 votes
    8y

    Keep in mind any real estate investment in an OZ must be a new build or a significant renovation (put 100% of cost back into the building(s)) 

    Turn key properties will not qualify. The investments must also be funded with capital gains.

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  • Dan Oxman
    Member since 2018 · 12 posts · 2 votes
    7y

    @Austin Hendrickson your last point isn't correct. You can defer taxes on capital gains invested in an OZ until 2026 while reducing your tax basis 15% so it's an added incentive to invest in OZ's. Gains realized from the investment itself is tax free if held for 10 years but as someone highlighted, you must improve the property by at least 100% of your purchase price. In other words, you likely need to demolish the existing structure and build something new. There are other details that may it challenging for a small investor to benefit from the OZ like spending the required capital within 30 months of closing and closing the property in an LLC.

    The OZ is really great because it goes off the 2011 census tract.  Since then obviously certain areas of the country have experienced more gentrification than others.  Therefore you can choose to invest in a part of the OZ that has gentrified where for example if a 2018 census tract were used today, likely wouldn't qualify today.  It's those areas that will be especially juicy to invest in. For example, in Los Angeles parts of North Hollywood, downtown LA and Koreatown are all in the OZ that may not qualify today.  Even if you don't invest in an OZ fund, buying a property in an OZ can be an excellent long-term investment as the area will improve.  

    More info on the preliminary IRS guidelines can be found here:  https://home.treasury.gov/news/press-releases/sm04...

    Final IRS guidelines should be out by the end of the year.

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  • Hector Bilbao
    Accountant · Fort Lauderdale, FL · Member since 2018 · 37 posts · 18 votes
    7y

    So Who Can Benefit?

    Any Real Estate Investor who realizes capital gains in 2018 and wishes to defer or eliminate the capital gains tax.

    How Do I Take Advantage Of It?

    – Invest your proceeds from the sale of stock, partnership interest, real estate property, into a Qualified Opportunity Zone. There are about 10,000 of these nationwide.
    – You have 180 days to reinvest your proceeds

    What Are The Benefits?

    – Any portion of the gain that’s realized by you the investor, from the sale of another investment, can be deferred if it is reinvested in one of the QOZ until as late as 2026.

    – Hold the property for 5 years and get 10% of the original gain permanently reduced. Invest for 7 years and it bumps to 15%.

    - Hold for 10 years and No gain recognized and no tax when electing Basis = FMV based.

    Let look at an example and do some basic math.

    Meet Bob

    -Bob sold Real Property on September 15, 2018. He makes $7.5 Million profit on the sale.
    -His Taxable Gain is $6M, the $1.5M difference is his return of capital for simplicity purposes.d He can do anything he wants with that $1.5M tax-free.
    -Bob decides to re-invest only his gain (because he only pays taxes on the gain) in QOZ on March 15, 2019. (6 months later)
    -For his 2018 tax return, he will make the appropriate election and pay no taxes on the gain that year.

    If Bob, holds the investment for 5 years, then 10% of his original gain is permanently excluded from tax. Meaning he pays taxes on a gain of $5.4M.

    If Bob, still holds the investment for 7 years, then 15% of his original gain is permanently excluded from tax. Meaning he pays taxes on a gain of $5.1M.

    If Bob, still holds the property for 10 years this is what happens.
    – On April 2027, he must pay the taxes deferred of $5.1M (because he can no longer defer them, even if you still hold the property).
    – On September 2028 he sells the property he acquired for $6M for $12M. Creating a gain of another $6M, but this time he gets to enjoy that completely tax-free. And the good news is that there is no cap, you can make $20M in profits and still pay no tax.

    Bob gets eight years of federal tax deferral, a reduction of 15% on the deferred gain, and tax-free proceeds on the sale of the QOZ property.

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  • Austin Hendrickson
    Investor · Minneapolis, MN · Member since 2016 · 139 posts · 143 votes
    7y

    @Dan Oxman My last point about the requirement to use capital gains for the investment is correct - in order to get the tax benefits of OZ's the investment MUST use capital gains. Cash investments are allowed but dilute the tax benefits.

    For example if someone uses $100k capital gains & $300k cash for an OZ investment then only 25% of the appreciation and depreciation are tax free. 

    The capital gain deferral until 2026 & 15% reduction in capital gains apply to only capital gains as well.

    I would recommend consulting with a CPA experienced in OZ's, there is a lot of misunderstandings floating around about OZ's.

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  • Dan Oxman
    Member since 2018 · 12 posts · 2 votes
    7y

    @Austin Hendrickson just wanted to make the point that you don't need to invest in an OZ fund with capital gains but the tax benefits would be diluted otherwise which I agree with and your example clearly shows.  Even just a straight cash investment into an OZ fund could be compelling given the tax-free potential after a 10 year hold period.

    And yes, most certainly consultant a CPA experienced with OZs but unfortunately those are limited given how new it is and we are still awaiting final IRS guidance which should be out by the end of this year.  

    The advantage to investing in an OZ property fund now is getting ahead of all those who are waiting for more clarity and final IRS guidance.  But that is a risk you must feel comfortable taking!

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  • Austin Hendrickson
    Investor · Minneapolis, MN · Member since 2016 · 139 posts · 143 votes
    7y

    @Dan Oxman A straight cash investment into an OZ fund would give rise to no tax benefits, thus defeating the purpose of investing into an OZ fund. 

    If you use a straight cash investment you do not have any tax-free potential. Capital gains must be used to get any tax-benefits.

    I am working with OZ's pretty closely with the firm I am at, if you have additional questions feel free to reach out.

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  • Dan Oxman
    Member since 2018 · 12 posts · 2 votes
    7y

    @Austin Hendrickson Are you sure? If you hold your investment in the OZ fund for 10 years then the resulting gains are TAX FREE at the Federal level. Is that not correct? This assumes a pure cash investment. Therefore, it is still very beneficial from a tax perspective to invest in an OZ fund for that reason alone, assuming of course the OZ project makes a decent IRR over the 10 year required hold period.

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

    @Austin Hendrickson Are you sure? If you hold your investment in the OZ fund for 10 years then the resulting gains are TAX FREE at the Federal level. Is that not correct? This assumes a pure cash investment. Therefore, it is still very beneficial from a tax perspective to invest in an OZ fund for that reason alone, assuming of course the OZ project makes a decent IRR over the 10 year required hold period.

    The resulting gains are tax free if held in the OZ fund for 10 years, but that original investment must consist of capital gains from the sale of an investment such as real estate or stocks.  The basis of that money goes up 10% then an additional 5%, thereby lowering your tax liability, but as far as gains made in the OZ fund, that has to come from money subject to capital gains taxes.

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  • Austin Hendrickson
    Investor · Minneapolis, MN · Member since 2016 · 139 posts · 143 votes
    7y

    @Dan Oxman Yes the investment must be derived from capital gains as @Tony Kim mentioned. A pure cash investment would not qualify for the OZ tax-benefits.

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  • Dan Oxman
    Member since 2018 · 12 posts · 2 votes
    7y

    @Austin Hendrickson, @Tony Kim I don't see that requirement in the actual bill where you can the find the link here:  https://www.congress.gov/bill/115th-congress/house...

    Special rules apply when capital gains are used to invest in an OZ Fund but nowhere does it specifically state that capital gains must be used.  For example the part on capital gains starts out with "a) Special Rules When Gain From Sale Of Property Invested In Opportunity Zone Property."  

    When capital gains are used special rules apply but not a requirement.  Perhaps I missed it and would love to see where in the bill it states that capital gains must be used.

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  • Aaron Gordy
    Real Estate Broker · Austin, TX · Member since 2012 · 1k+ posts · 1k+ votes
    7y

    This is all very good stuff. Thanks for sharing. I have been keeping an eye on this and now it seems like its happening. I think its a game changer! 

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

    @Austin Hendrickson, @Tony Kim I don't see that requirement in the actual bill where you can the find the link here:  https://www.congress.gov/bill/115th-congress/house...

    Special rules apply when capital gains are used to invest in an OZ Fund but nowhere does it specifically state that capital gains must be used.  For example the part on capital gains starts out with "a) Special Rules When Gain From Sale Of Property Invested In Opportunity Zone Property."  

    When capital gains are used special rules apply but not a requirement.  Perhaps I missed it and would love to see where in the bill it states that capital gains must be used.

     https://www.congress.gov/bill/115th-congress/house-bill/828/text#toc-H2CE36B67ACCC4F89BD0B2571450C0176

    The portion of an OZ fund interest attributable to any capital invested in excess of the qualified gain amount is not eligible for the OZ tax exemption. 

    Also, just stop and think about what it would mean if your understanding is correct. This would pretty much mean the extinction of the standard value-added syndicated deal.  Why would anyone invest in any non-OZ value-added syndicated deal if all they had to do to avoid capital gains taxes was to maintain a ten year holding period? Each OZ fund would be set up for zero distributions till year ten when the property is sold and RG proceeds and ROC distributions are made.

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  • Dan Oxman
    Member since 2018 · 12 posts · 2 votes
    7y

    @Tony Kim are you quoting from the tax bill?  I don't see that language in there.  

    I agree, the OZ is certainly a threat to real estate syndicated deals but most of those deals are shorter-term, not 10 years.  However, I agree that if your view is a 10 year hold period then why would you invest in any real estate fund or project that isn't an OZ?  The obvious answer is that you don't believe OZ areas will appreciate as quickly as non-OZ areas.  Also to be clear, most OZ funds are structured with distributions periodically from income from the property (once developed) which is taxable and after 10 years any capital appreciation on the investment is exempt from capital gains tax.  It's not dissimilar to owning a property today if you have the intention and ability to hold it for 10 years.  

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  • Austin Hendrickson
    Investor · Minneapolis, MN · Member since 2016 · 139 posts · 143 votes
    7y

    @Dan Oxman you are not the only person to initially think cash could be invested and give rise to tax benefits, it is a common misconception.

    I have confirmed this with OZ leaders in our firm as well as a few OZ syndicators and the OZ lead at a large Big 4 firm. All are in agreement that cash investments do not give rise to tax benefits at this point in time.

    Bottom line is that capital gains must be used. There is some talk on wanting the IRS to clarify if it must be capital gains or if ordinary gains would qualify as well due to certain language that only refers to "gains"

    From what I have heard the reasoning behind requiring capital gains to fund OZ investments is to trigger sales and spur economic activity (you must have a sale to trigger capital gains) as well as to get some idle capital gains taxed even if they are deferred until 2026.

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  • Austin Hendrickson
    Investor · Minneapolis, MN · Member since 2016 · 139 posts · 143 votes
    7y

    @Dan Oxman as far as where in the code it says only capital gains are allowed:

    The benefits OZ's of sub section Z (1400Z-2) are spelled out under the 1400Z-2 heading "Special Rules for Capital Gains Invested IN Opportunity Zones" - this means that the OZ benefits ONLY apply to OZ investments funded with capital gains.

    Under 1400Z-2(e)(1) it spells out that any investment that consists of only a portion of gains will be broken out into two separate investments, with only the capital gain portion giving rise to any tax benefits. The non-gain portion will not have any tax benefits.

    The tax code is very complex and hard to read which is why having a good tax CPA on your side can save you on the front end. 

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