Opportunity Zones - Investment Net

Opportunity Zones are a type of economic development strategy that allows people to invest in economically challenged areas of the US. Their goal is to help low-income communities prosper and create jobs while also providing tax breaks to investors. The 2017 Tax Cuts and Jobs Act established Opportunity Zones (Public Law No. 115-97). Thousands of low-income areas have been designated as Qualified Opportunity Zones in all 50 states, the District of Columbia, and five US territories. Qualified Opportunity Funds allow taxpayers to invest in these zones.

Qualified Opportunity Zones

A Qualified Opportunity zone is an economically challenged community where new investments may be eligible for special tax treatment under specific conditions. Localities qualify as QOZs if they were nominated for that designation by a state, the District of Columbia, or a United States territory, and that nomination was confirmed by the Secretary of the United States Treasury via his delegation of power to the Internal Revenue Service (IRS).

Census tracts required to be “low-income” to be considered an Opportunity Zone. To do so, the census tract had to meet at least one of the following criteria:

A poverty rate of at least 20% exists in the tract; OR

(A) The median family income of a census tract in a metropolitan area does not exceed 80% of the greater of the metropolitan area median family income or the statewide median family income; or (B) the median family income of a census tract in a non-metropolitan area does not exceed 80% of the statewide median family income.

If the census tract is in a high-migration rural county, however, it qualifies as low-income if it does not surpass 85 percent (rather than 80 percent) of the statewide average.

Investments in opportunity zones receive special tax treatment so investors can reinvest their capital gains without including them in their taxable income. However, It’s the long-term investment that offers the most benefits. Specifically, opportunity zone investments can permanently exclude their earnings from taxable income provided the investor holds them for a minimum of ten years.

Yet, some opportunity zones will prove more lucrative than others. As not all opportunity zones are created equal.

While the prospective tax benefits of an investment are appealing, they cannot compensate for a poor real estate investment. At the best of times, property development entails significant risks. Investors should keep in mind that opportunity zones are defined as regions where development has not occurred naturally. According to National Real Estate Investor, investments in numerous opportunity zones can have higher risk profiles.

Investors in opportunity zones must keep in mind that these are still real estate investments first and foremost. Consequently, real estate developers and investors must analyze each transaction based on the fundamentals of the property.

For opportunity zone investors, competition is posing its own set of problems. Due to fierce competition among qualifying opportunity funds and a tiny number of truly high-quality properties in the economically distressed areas covered by opportunity zones, good deals are difficult to come by. According to the The Wall Street Journal, this, along with an obvious fear of losing out, has resulted in developers and investors buying now and planning for the future later.

It’s rarely a good idea to go headfirst into an expensive, long-term real estate venture.

To make a profit, a taxpayer must sell an asset and realize a capital gain. The capital gain is then invested in a Qualified OZ fund by the taxpayer. Finally, there is a delay and reduction in taxes owed to the government — if held for ten years, the taxpayer can pay no capital gains tax on the new investment in the fund.

Eligible Gain Deferral

The term “eligible gains” refers to gains that can be deferred. This includes both capital gains and qualified 1231 gains, but only those allocable to federal income tax before January 1, 2027, and not from a transaction with a related person. To qualify for this deferral, the eligible gain amount must be invested in a QOF and exchanged for an equity interest in the QOF within the specified time frame (qualifying investment). Once this is completed, the taxpayer is entitled to claim the deferral for the taxable year in which the gain would have been recognised if it had not been for the deferral.

Identifying the right opportunity zones

Thousands of zones have been designated as opportunity zones throughout the country, but few offer investing opportunities that are truly exceptional. Those zones with valuable opportunities for economic development as well as relatively easy paths to a broader community revival are the real gems. Many of these neighborhoods have already seen an urban revival after being designated as opportunity zones. A multibillion-dollar football stadium will soon be built in the Inglewood neighborhood, which should boost local economic growth. Investing in the nearby opportunity zones may provide investors with both secular growth and property-specific profits.

Identifying the best opportunity zones

Many opportunities zones have been designated across the country, but only a few have proven to be worthy investments. The real treasures are the areas that provide both valuable economic development potential and relatively simple avenues to broader community revitalization. A textbook illustration of such an opportunity can be seen in downtown Los Angeles. Several communities have been classified as opportunity zones, with several of them already undergoing urban revitalization. A multibillion-dollar football stadium is about to be built in the Inglewood area, which is intended to encourage local development. Investing in the surrounding opportunity zones may provide investors with the possibility to profit from both secular and property-specific development.

What Are Opportunity Zone Funds and How Do They Work?

Opportunities zones offer lower capital gains tax rates. Any corporation or individual can invest unrealized capital gains in an opportunity fund.

Active real estate investors establish various Qualified Opportunity Funds, whether through partnerships, limited liability companies (LLC), or corporations. The fund must file the necessary paperwork and follow IRS regulations. Any assets they invest in must be operational, abandoned, or undeveloped, and they must show significant improvement within 30 days of purchase.

Investing in Opportunity Funds requires you to transfer cash or property to a Qualified Opportunity Fund, according to the IRS. Due to the nature of noncash property, only a portion of the investment may be eligible for tax benefits. To receive the tax benefit, you must comply with annual investor reporting requirements and make your investment within 180 days of realising your capital gain.

Who can create an Opportunity Fund?

Anyone with a tax-exempt status can establish an Opportunity Fund, by self-certifying. Forms (expected for release in the summer of 2018) must accompany a taxpayer’s federal income tax return.

What types of businesses will be eligible to participate in a QOF?

Many different types of businesses can qualify, including manufacturing and distribution, as well as real estate developments such as mixed-use, retail, and apartments, to name a few. A business must meet the definition of QOZ business property, which has an original use test or a substantial improvement test, in order to qualify.

Initially, QOZ business property must be used for a QOF or a QOZ business, according to the original use test (e.g., a newly constructed building). During the 30-month period following the acquisition of the property by the QOF, the basis in the property (excluding any land) may also increase by more than the adjusted basis at the time of acquisition.

Can inventory be considered QOZ business property?

QOZ business property can include inventory (including raw materials). Furthermore, you may choose to exclude inventory from QOZ business property and from the denominator of the applicable determination on an annual basis (whether 90 percent or 70 percent). Inventory must be handled consistently during each taxable year, regardless of whether inventory is included in QOZ business property or the denominator.

Is it possible to classify inventory in transit as QOZ business property?

If a QOF or QOZ business’s inventory, including raw materials, is in transit, the inventory may qualify as QOZ business property. In other words, inventory does not fail to qualify solely due to its transit from a vendor to a QOF or QOZ business or from a QOF or QOZ business to a customer.

What gains are eligible for opportunity zones?

An Opportunity Zone investment requires only the capital gain portion of the transaction to be reinvested. The time horizon is another difference. For a 1031 exchange, the step-up in basis only occurs upon death

What types of profits may I defer if I put money into a QOF?

“Eligible gains” are gains that can be delayed. They include both capital gains and qualifying 1231 gains, but only gains realized for federal income tax purposes before January 1, 2027, and not through a transaction with a related person. To qualify for this deferral, the amount of the eligible gain must be promptly invested in a QOF in exchange for a share of the QOF’s equity (qualifying investment). You can then claim the deferral on your federal income tax return for the taxable year in which the gain would otherwise be recognised if you had not deferred it.

In an Opportunity Zone, how long do you have to build?

You have 180 days to invest an eligible gain in a QOF in most cases. If you did not decide to defer the recognition of the gain, the gain would be recorded for federal income tax purposes on the first day of the 180-day period.

Is it possible to invest in opportunity zones without making a profit?

Capital gains taxes can be reduced, deferred, or even avoided in opportunity zones. They favor long-term investors who are willing to hold their property or equity for a minimum of ten years. To fully profit from the tax advantages of opportunity zones, you must first invest capital gains from another asset.

Benefits of Investing in Opportunity Zones

For investing unrealized capital gains in Opportunity Zones, the programme offers three tax benefits:

Tax deferrals on previously earned capital gains for a certain time. An opportunity fund can be invested with existing assets that have accrued capital gains. There will be no taxation on existing capital gains until the end of 2026, or until the asset is sold.
Investment of previously earned capital gains with a step-up in basis. Investors’ base on the original investment increases by 10% if capital gains are held in Opportunity Funds for at least 5 years. Investors’ base on the original investment improves by 15% if they invest for at least 7 years.
New gains are permanently exempt from taxation. Investors in Opportunity Funds pay no taxes on any capital gains generated by their assets if they hold them for at least ten years (the investment vehicle that invests in Opportunity Zones).

Time limit for making investments in an Opportunity Fund

The IRS rule-making process determines this timeframe. According to the legislation, an Opportunity Fund may be required to invest 90 percent of its capital in Opportunity Zone Property within the first six months of the Opportunity Fund’s taxable year. The rulemaking process may include some timing relief to allow for a 12-month investment window. In order to receive the tax benefits, the investor must invest in an Opportunity Fund within six months of realizing the capital gain.

Why is there a 180-day deadline for making an Opportunity Zone investment set by the IRS?

Once you’ve realized a profit, you cash it out. You now have X number of cash in your possession. Because 180 days is a significant amount of time, the IRS gives you 180 days to select or form an Opportunity Zone Fund. Because Section 1031 gains take the same amount of time, the 180-day rule was likely employed. However, it must be less than a year because if it is longer, it will be considered an additional year of deferment, which is not included in this programme. They want that money to be spent in these census tracts as soon as possible.

How to avoid capital gains tax?

Capital gains tax is avoided by investing in a Qualified Opportunity Zone Fund within 180 days of the sale. With the deferred gain step-up basis, you would be given a $100,000 basis, which is 10% of the original $1 million capital gain deferred.

What happens if a company in Oz relocates? Is there a risk of recapture?

There is no recapture risk, but an opportunity fund that fails to meet the fund’s 90 percent asset requirement will be penalized for each month it fails to meet the requirement. The penalty is not intended to be severe, but rather to ensure that funds remain within the parameters of the zone. When an asset no longer qualifies, there will be a grace period during which it can be disposed of without incurring penalties.

Is it possible for the Opportunity Zone Fund to borrow money?

Qualified Opportunity Zone Funds (QOZF), like traditional real estate investment vehicles, may use financing strategically to help maximize returns. Using debt or leverage has advantages and disadvantages; it prioritizes payment, magnifies returns in both directions, and provides income tax shelter.

Is it possible for an opportunity zone fund to invest in another opportunity zone fund?

New rules allow taxpayers to self-certify as an Opportunity Fund by completing Form 8996. You cannot participate in another opportunity fund if you own one already. You’d have to make a direct investment in the operating entity. Individuals can invest in qualified opportunity zone funds.

Can Opportunity Zones be modified?

No. The boundaries of an Opportunity Zone cannot be changed under the current federal programme.

Is an accredited investor required to invest in opportunity zones?

The program’s irony is that the majority of opportunity zone funds are exclusively open to accredited investors. Accredited investors are those who have been granted preferential treatment under financial regulations. They are usually high-net-worth individuals or entities.

Can an LLC invest in an Opportunity Zone?

For an LLC to qualify as a Qualified Opportunity Fund, it must be taxed either as a corporation or a partnership. Qualified OZ funds held by LLCs are treated the same way as other funds for Internal Revenue Code purposes.

Conclusion

Understanding capital gains tax is essential before investing. If you have significant capital gains, investing some of your cash or assets in an opportunity fund may be well worth it.

There are thousands of opportunity zones. Each state and territory has a different strategy for making them work. Furthermore, different Qualified Opportunity Funds operate in these zones. You should look into where your money is going and why it is going there.