What exactly is an Opportunity Zone?

In my previous article I wrote about tax advantages of the 2017 Tax Cuts and Job Act (TCJA). In this article, I would like to expand about the U.S. Treasury Department proposed regulations for the federal Opportunity Zone tax incentive program that was created under the TCJA. Take note that while these regulations provided clarity, investors have to be aware that additional regulations still need to clarify some finer details.

What is an Opportunity Zone?

An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.

Furthermore, the program is not limited to any specific product type, and it does not mandate any job creation requirements in a Qualified Opportunity Zone. In short, any investor with capital gains from the sale of property and developers or owners of any property type, such as multifamily rental, commercial, self-storage, assisted living, or any other type of property, can take advantage of this program.

Qualified Opportunity Zones are located in low-income communities in every state in the United States, as well as Puerto Rico. A detailed interactive map of the Opportunity Zones across the United States is found at this link.

What are Tax Advantages of Investing in Opportunity Zones?

Every real estate investor highly anticipated clarity from Treasury since the creation of the Opportunity Zone program last year, and the regulations for the federal Opportunity Zone tax incentive program are expected to be a terrific boost to the real estate equity capital investment in low-income and distressed communities.

Simply put, this program offers significant capital gains tax benefits for taxpayers who invest in projects and businesses in low-income areas, allowing investors to delay, reduce and even eliminate capital gains taxes on appreciated assets or business located in and on Qualified Opportunity Zone investments.

January 2018 The Opportunity Zones program offers three tax benefits for investing in low-income communities through a qualified Opportunity Fund:

• A temporary deferral of taxable income for capital gains reinvested in an Opportunity Zone.
• A step-up in basis for capital gains reinvested in an Opportunity Zone. The basis is increased by 10% if you hold the investment for at least 5 years, and if you hold the investment for at least 7 years the basis increases by an additional 5%, for a total of 15% of the original gain that can be excluded from taxes.
• A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in an Opportunity Fund if you hold the investment for at least 10 years.

The above three bullets basically mean that investors can delay paying federal income tax on capital gains until as late as Dec. 31, 2026 as long as the gains are invested in Qualified Opportunity Funds that have 90% of their assets in property located in a Qualified Opportunity Zone.

An even better deal is realized if you held the investment for at least 10 years in which case your investment gains can be federal income tax-free. More specifically, appreciation of investments in real estate within the Opportunity Zones that are held for at least 10 years are not subject to federal capital gains tax if you sell the investment before Dec 31, 2047.

In short, the longer you hold your investment within a Qualified Opportunity Zone within an Opportunity Zone, the more your capital gains are reduced.

Use It or Lose It

If you decide to take advantage of the Opportunity Zone program of the tax benefit, you need to hurry because of the enormous demand, as well as due to the shrinking time period. Specifically, the program will only be available until 2026, and if you do not invest by 2019 you will forfeit your ability to reduce capital gains by 15 percent in seven years. Likewise, in order to reduce your capital gains by 10 percent, you need to make your investment by 2021.

Speaking of moving quickly, don’t forget that you will have to reinvest the capital gain from the sale within 180 days in order to defer short- and long-term capital gains.