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Posted about 1 year ago

Understanding Opportunity Zone Investing

Opportunity Zones (OZ) are an incentive programs intended to benefit low income communities nationwide. These zones are geographic areas designated as having both a high need and a high potential for revitalization. There are over 8700 opportunity zones in the United States, and since 2018 these opportunity zones are responsible for setting aside $6 trillion in unrealized capital gains.

A qualifying census tract, which is simply a subdivision of a county, must have a poverty rate of 20% or more and a median family income that’s less than 80% of the larger area’s median income. If for example, the area’s median income is $50,000 per year, a census tract would need to have a median family income of $40,000 or less per year to potentially qualify as an opportunity zone.

The OZ program provides tax breaks to investors on capital gains earned by investing in these neighborhoods. However, in order to receive these tax breaks, investments must be held within an Opportunity Zone Fund. An OZ Fund is a legal entity such as a corporation that holds at least 90% of its assets in qualifying opportunity zones.

Existing, realized capital gains (i.e. profits already earned) must be reinvested in an OZ Fund within 180 days of the gain. The entity then qualifies for a deferral on taxes that would otherwise be due on the capital gains. In this respect, and OZ Fund is not unlike a 1031 exchange -- profits are reinvested in a qualifying manner and receive the benefit of income taxes being deferred. In the case of an OZ Fund, taxes are deferred until either the newly acquired asset is sold or December 31, 2026.

For those investors who got involved early in OZ, there were not only tax deferrals, but the ability to decrease their tax burden. Holding an asset in an OZ Fund for five years for example would lead to a 10% reduction in the capital gains subject to taxation. If for example, you had $1 million in capital gains, but held the asset for five years, you would only be taxed on $900,000. However, since we’re less than five years from 2026, unless the program is extended the current benefit for new investors in opportunity zones is the deferral of taxes and not their reduction. At the time of this writing, there is a proposal to extend the deadline to December 31, 2028.

As mentioned earlier, assets must be held in a qualifying OZ Fund. In order to self-certify, that is to establish your entity as a qualifying OZ Fund, you’ll need to complete a form with the IRS on an annual basis confirming that the entity meets the qualification criteria, namely that 90% or more of the assets held within the fund exist in an opportunity zone.

Comments (1)

  1. This is great Mark, thanks for sharing!