Opportunity Zones are a concept that has its roots in both the Republican and Democratic parties. Their inclusion in the Tax Cuts and Jobs Act of 2017 helped ensure their passage even though the Act itself was a political piece of legislation.
The goal is to get people from other states to invest in commercial businesses and residential real estate in different parts of the United States that have been singled out as having bad economies.
To encourage investment, the Act provided a mix of high tax deferral and tax avoidance on gains from the sale of real estate, stocks, art, or any other capital item, as long as those proceeds were reinvested in Opportunity Zones or “OZ” firms or real estate.
The 2012 JOBS Act, which permitted sponsors to advertise to investors with whom they had no prior contact- a legacy of the 1933 Securities Act- has offered investors one of the best real estate investment opportunities.
There has been a lining up of forces. So, the combination of the 2012 Act allowing broad solicitation and the 2017 Act provides considerable tax benefits to encourage investment. It has resulted in OZs becoming among the most popular real estate classes developed in recent decades.
They have caught the attention of both domestic and foreign capital, which even worsened the Act’s impact on liquidity.
Unfortunately, a large percentage of people and businesses interested in opportunity zones still harbor misconceptions about them because the program and concept are still in their infancy.
The following is some information that will shed light on how they function and how you can begin to make use of them.
What Exactly Is an Opportunity Zone?
Since the Clinton administration, there hasn’t been a new government program that uses tax incentives to help build a community.
This program gives high tax breaks to people who reinvest their capital gains in areas with bad economies.
Here are a few of the provisions that were put in place by the state governors to define “economically distressed.”
- The poverty rate in a census tract had to be at least 20%.
- Incomes could not be 80% higher than the metro or state average.
- In effect until 2028, the designation will be in place.
- Census tracts may be contiguous to regions that meet these criteria even if they do not meet the standard themselves in 5% of cases.
Investors must put their money into a specific investment account called an Opportunity Fund if they want to take advantage of the tax benefits these funds offer.
These companies must invest at least 90% of their assets in opportunity zones.
Businesses are eligible for investment from funds as well. However, to qualify, enterprises must generate at least half of their annual revenue from the active operation of a business within an opportunity zone.
The main benefit of the zones is that they allow people to put off paying taxes on capital gains until the year 2026.
Taxes are reduced by 10% if capital is held for at least five years in an OZ.
There is a further 5% reduction at the end of the 7th year, and the gains are tax-free after ten years.
Capital must be invested in an Opportunity Fund within 180 days of the gain, so they operate similarly to the 1031 exchange but with a longer reinvestment window.
Investors are drawn to these funds because they can defer all long-term and short-term capital gains, regardless of how or when they were earned.
There is a tiered scale of tax forgiveness, but capital can grow tax-free and be removed through the sale for ten years without generating any capital gain liability if kept for that long.
Opportunity Zones’ Impact
As the program is still in its infancy, it is hard to discuss the impact of opportunity zones without relying on anecdotes. Although there is a lot of positive talk about opportunity zones with a great deal of capital being raised, not as many transactions have occurred as you might expect.
However, other agreements are close to closing, so we may soon have a clearer understanding of opportunity zones and their impact on market dynamics.
Moreover, while there is a great deal of interest in equity offerings from independent fund managers, it shows that family offices are the first to initiate the process.
It is because they have easy access to funds and can move swiftly.
It’s impossible to ignore how the prices of goods and services will change in the future because of opportunity zones.
Some opportunity zone prices are already rising by 5 to 10%, but this is not universal. Most opportunity zone capital is likely to be invested in places that are gentrifying or have strategic value.
Concerns Regarding Opportunity Zones
Even though developers, investors, and tenants all stand to gain from the opportunity zones program, there are a few issues that still need to be addressed and resolved. The Treasury hopes to do so soon.
For example, funds that want to buy and manage a lot of assets in a single fund have a hard time doing so, and leaving a fund with a lot of assets still has different tax implications.
How would people who already own real estate, especially those who owned property in opportunity zones before the program started, be able to join this new program?
The Treasury is working hard to clarify these difficulties.
Taxpayers’ Possibilities for Using Benefits
For taxpayers to be able to take advantage of the benefits of opportunity zones, they need to think about the following three main things:
- The principal advantage is a reduction or removal of responsibilities related to long-term and short-term capital gains taxes, regardless of how the obligations were incurred.
- These gains must be reinvested in Opportunity Funds within the 180-day window beginning on the date of the sale. But investors don’t have to put all their profits from a single trade back into Opportunity Funds.
- To notify the government that the deferral of profits scheme is used, taxpayers should complete Form 8949.
Participation in the program will necessitate familiarizing yourself with the locations of nearby opportunity zones.
The following section contains the extra materials.
There is a lot of interest in a wide range of property types for these places, but the best choice will depend on the exact location.
Opportunity Zone Obstacles
There are many factors to consider before investing in an opportunity zone or any other real estate investment, but the most important is that the transaction must make sense.
If the investment is a failure, there is no use in taking advantage of a tax break.
Investors who want to take advantage of the tax breaks offered by opportunity zones have to deal with three big problems.
OZs have several disadvantages. First of all, most of them are in areas that are labeled “distressed” by the state and this makes them less appealing to real estate investors.
Sponsors will have a hard time finding deals, but being able to include tax benefits in proforma predictions should give them an edge over those that aren’t offered through OZ.
Because there is so much competition, it will be hard for OZs to find and develop viable sites. This will lead to higher prices and less viability, which makes them so appealing.
Thirdly, because the laws are so new, they have not yet been tested. Thus, cautious investors may wait until Treasury Department instructions are clear before investing.
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