In an era of divided government and even more divided politics, there are still public policies that can unite the left and right. One is opportunity zones.
Opportunity zones (OZs) – defined by the IRS as economically-distressed communities where new investments, under certain conditions, may be eligible for preferential tax treatment – were added to the tax code by the Tax Cuts and Jobs Act of 2017.
OZs are primarily an economic development tool designed to spur job creation and economic development in communities prime for growth. They also can provide significant tax benefits to investors.
When an investor sells an asset, it’s possible to defer paying capital gains taxes until 2026 if the gain is reinvested in a Qualified Opportunity Fund, the vehicle created to invest in opportunity zones.
It’s also possible to reduce or potentially eliminate a tax burden. According to the IRS, “if the investor holds the investment in the Opportunity Fund for at least 10 years, the investor would be eligible for an increase in basis equal to the fair market value of the investment on the date that the investment is sold or exchanged.”
In a July 2019 webinar hosted by NAIOP, Allen Gregory, lead federal tax partner at TaxOps and founder of AG Tax and Consulting, explained four criteria investors must meet to achieve the tax benefit:
- Investment must be in property that is located in a designated federal opportunity zone.
- The property must be tangible property, currently used in a trade or business.
- The property must have been acquired after December 17, 2017.
- The investment must deliver new construction or “substantially improve” the existing property.
Gregory says that if these criteria are met, opportunity zones can provide a better tax benefit than more traditional vehicles, such as a 1031 exchange.
For example, OZ profits can be tax-free if the investment is held long enough and is timed correctly, while a 1031 exchange cannot eliminate tax on basis. Also, OZs can provide flexibility to investor partnerships that are looking to dispose of property. If some partners decide to take gains in a transaction and others don’t, the new law allows the partners to defer the gains by reinvesting in an OZ, regardless of what the larger partnership does.
There are some requirements that must be met, of course. For example, Gregory says that in order to qualify, a qualified opportunity fund must have 90% of its assets in a qualified opportunity zone property.
The webinar showed how some are already finding ways to use the law.
Mark Kennedy is a venture capitalist who says he’s working where real estate and technology meet in Opportunity Zones. As chief investment officer of the FUEL.LA Innovation Hub and opportunity zone fund, Kennedy believes OZs will change the face of commercial real estate, and he’s launched “hybrid” qualified opportunity funds to combine investment in real estate and high technology companies.
Kennedy says OZs are a great investment opportunity, because investors “can defer capital gains from any legitimate source, not simply real estate.” He says he’s working with tech entrepreneurs who are cashing in their stock options and reinvesting the gains in opportunity zones. If they keep their investment in place for a decade, he says the zones will deliver big benefits to the investors. “Once you’ve gone beyond the 10-year hold, you pretty much hold control [of the gains]. There’s no limitation as with a 1031, where you have to reinvest.”
Kennedy considers opportunity zones to be a “combination of a 401(k), a Roth IRA, a 1031 and a college savings plan, with a little bit of a health savings plan rolled in as well.” He adds that his company sees OZs as more than a tax strategy and believes they could actually “change the direction of where real estate development is headed,” especially in areas close to existing urban development. He urges investors to take the long view on OZs.
Lawmakers are considering some minor changes, as Senators Cory Booker (D-NJ) and Tim Scott (R-SC), the original Senate authors of the opportunity zone tax incentives plan, are pushing to reinstate requirements for the Treasury Department to collect data on and disclose the tax breaks’ progress – a provision lawmakers took out of the 2017 tax law before its passage.