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    Investing in "Opportunity Zones" Brings Tax Benefits to Investors
    The Vault

    Investing in "Opportunity Zones" Brings Tax Benefits to Investors

    August 2018

    Tax Benefits to InvestorsLeaders in Washington and beyond are hoping that another element of the Tax Cuts and Jobs Act, one that creates tax incentives for investing in low-income areas, will boost economic revitalization efforts. “Opportunity zones” have been established nationwide, and investors will be able to earn tax breaks for buying stakes in real estate or companies that are taking root in areas tagged as needing an economic boost. Here’s what you need to know.

    What is an Opportunity Zone?

    An opportunity zone is a census tract -- typically a section of a town or municipality --  that generally must has a poverty rate of 20% or a median family income of up to 80% of the area median. New tax law gives state governors the authority to submit such communities for approval (by the Secretary of the Treasury) as opportunity zones. Treasury has 30 days to certify an area as Qualified Opportunity Zone from the date it receives the nomination.

    To date, these states and territories have received approval from the Secretary of Treasury for the zones nominated. (This list will be updated as changes occur.)

    Each Opportunity Zone retains its designation for 10 years. Investments in Opportunity Zones are made through Opportunity Funds, as described below.

    What is an Opportunity Fund?

    A Qualified Opportunity Fund is an investment vehicle that must hold 90% of its assets in Qualified Opportunity Zone Property, which includes Qualified Opportunity Zone Stock, Qualified Opportunity Zone Partnership Interest, or Qualified Opportunity Zone Business Property. If investors realize a gain from the sale or exchange of a capital asset to an unrelated party, they have 180 days from the date of disposition to reinvest the gain amount with a cash investment into a Qualified Opportunity Fund. The investor receives either stock or an interest in the fund and then must invest in Qualified Opportunity Zone Property. If investors hold the interest in the fund for at least five years, they receive a basis increase in the investment that equals 10%  of the deferred gain they invested in the fund.

    If investors hold their interest in the fund for an additional two years (seven years total), they receive an additional increase in their basis that equals 5% of the deferred gain invested in the fund. If investors are still holding their interest in the fund on Dec. 31, 2026 then, regardless of if they continue to hold the interest in the fund, they are required to recognize and pay taxes on the deferred gain on that day, subject to any increases in basis they may have received for holding the property for five years or more. If investors continue to hold the interest in the fund after Dec. 31, 2026, for at least a total of 10 years, they receive a step up in basis in the interest so their basis equals the fair market value; therefore, they are not taxed on any appreciation in their interest. In order to receive a 10%  increase in basis, the investor must invest in a fund by 2021 and in order to receive an additional 5% increase in basis, the investor must make an investment in a fund by 2019.

    Real estate developers can establish a fund in order to generate third-party investment capital for their projects.

    If a fund fails to meet the 90% standard, it is subject to a penalty for each month it fails to meet the required threshold. The penalty is "(i) the amount equal to 90 percent of its aggregate assets, over (ii) the aggregate amount of qualified opportunity zone property held by the fund, multiplied by the underpayment rate established under [Code] section 6621(a)(2)" for each month the Fund fails to meet the required threshold. IRC § 1400Z-2(f)(1).

    IRS says it will soon release a form that will allow taxpayers to self-certify as a Qualified Opportunity Fund. That form will be attached to the income tax return. We’ll be sure to update you if that occurs.

    What tax benefits are available?

    Investors in opportunity zones can benefit in the following ways:

    • Reducing their tax liability if they invest in a company in the zone and then sell their stake for a profit after staying in it for 10 years or longer.
    • Rolling over capital gains from other investments into an opportunity zone investment. This can provide as much as a 15% tax break for someone who sticks with the opportunity zone investment for at least 7 years.
    • Investments can be done individually or through a special fund that can be set up to coordinate investments in a specific opportunity zone community.

    These tax breaks, advocates say, have the potential to grow each state’s economic base by directing capital into areas that generally don’t generate investor interest.

    How to Qualify/Next Steps

    There are multiple fine details of each requirement (stock, partnership, business property, passive investment) necessary to receive the tax incentives. Please reach out to us for assistance to determine if you qualify. The potential for tax savings and for entire neighborhood revitalization is tremendous, but navigating these waters alone will be difficult.

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