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Investment Planning

Opportunity Zone Investments 101

The Opportunity Zone program is relatively new and unfamiliar to many investors since being established as a result of the Tax Cuts and Jobs Act passed in late 2017. The CAIS article copied below is a nice high-level summary of what Opportunity Zones are and their potential impact on investors and communities.

Opportunity Zones – Frequently Asked Questions

Q. What is an Opportunity Zone?

An Opportunity Zone is an economically distressed community selected for revitalization and redevelopment by the Opportunity Zone program. The aim of the program is to stimulate private investment into disadvantaged areas that have otherwise been unable to attract investment by offering investors significant tax incentives.(1)

Q. How were Opportunity Zones Created?

Opportunity Zones were created by the Investing in Opportunity Act, a provision of the broader Tax Cuts and Jobs Act of 2017. (1)

Q. What is the purpose of Opportunity Zones?

Opportunity Zones seek to encourage long-term economic development and spur job creation within struggling communities. (1)

Q. How were Opportunity Zones selected?

State and territory governors were empowered by Congress to nominate up to 25% of their state’s low-income community census tracts for inclusion in the Opportunity Zone program. A low-income community census tract is an area which has a poverty rate of at least 20 percent or where the median family income is less than 80 percent of the surrounding area. Additionally, governors were able to substitute up to 5 percent of their nominated tracts with tracts that may not have met the low-income standards, but which were contiguous with other nominated low-income community tracts. These nominated communities were then certified by the Treasury Department. (3)

Q. How many Opportunity Zones are there?

There are 8,762 Opportunity Zones. Of these, 8,532 are low-income community tracts and 230 contiguous communities.(2)

Q. How can investors access Opportunity Zones?

Investors can access Opportunity Zones by investing in an Opportunity Zone Fund (OZF). An OZF is an investment vehicle structured as a corporation or partnership that was formed specifically for the purpose of investing in qualified opportunity zone assets and that holds at least 90 percent of its assets in qualified opportunity zone assets.

Q. What are the incentives for investors to invest in Opportunity Zones?

There are three primary tax-based incentives associated with the Opportunity Zone program. They include:

  • Deferral of capital gains tax from other investments
  • A step-up in the basis of the capital gains invested into an Opportunity Zone based on the length of the holding period, and;
  • Tax free growth of the Opportunity Zone investment if it is held for a total of 10 years (2)
Q. What type of capital gains can be invested into an Opportunity Zone Fund (OZF)?

Both short- and long-term gains from the sale of stocks, bonds, property and interests in partnerships are eligible for investment in an OZF. (4)

Q. How long after realizing a capital gain do the proceeds from a sale need to be invested into an OZF?

Realized capital gains need to be invested in an OZF within 180 days. (2)

Q. What are the step-up rates on the deferred capital gain?

If an investment in an OZF is held for 5 years, the basis on the deferred capital gain is stepped up by 10 percent. If the investment is held for 7 years, the basis is stepped up by an additional 5 percent. The maximum step-up is 15 percent. (3)

Q. When are the taxes on the deferred gains invested into an Opportunity Zone investment due?

Taxes deferred through the program are due at the time the investment in an OZF is sold, or December 31, 2026, whichever is earlier. This means that taxes will likely be payable prior to the end of the fund life. (3)

Q. To receive the step-up rates on the deferred capital gain, when will an investment into an OZF need to be made?

Investors will receive the maximum step-up on the deferred gain after 7 years. Since the last date for paying taxes on the deferred gain is December 31, 2026, investors will need to be invested in an OZF by December 31, 2019 to realize the maximum step-up benefit of 15%. Failing to meet this deadline still leaves them eligible to receive the 10% step-up after 5 years and to receive this they will need to be invested in an OZF by December 31, 2021. OZF investments made after this will not qualify for the step-up in basis on the deferred gain but will qualify for tax free growth of the investment if held for at least 10 years. (2)

Q. What types of investments can be made under the Opportunity Zone Program?

Much of the focus of the Opportunity Zone program has been focused on real estate investments. However, under the program, eligible investments can include natural resources, manufacturing, transport hubs, etc. so long as they are in one of the qualified opportunity zones. (3)

Q. Are there any guidelines concerning the underlying investments made by an OZF?

Assets within an OZF must;

  • Be put to new use
  • Be substantially improved by investing at least the amount of the purchase price to further develop the site (excluding land)

Additionally, every six months an OZF is required to furnish the IRS with a list of Opportunity Zone assets that they have closed on or have signed a letter of offer. (4)

Q. What is the initial investment period of the OZF?

Once capital is called, the manager of an OZF must meet certain asset tests twice a year. Following these asset tests, the manager has 31 months to invest the proceeds. If this is not completed, the OZF will fail to qualify for the program and investors will not realize the programs associated tax benefits. (2)

Q. Can I continue to hold an OZF indefinitely to continue to benefit from the tax-free growth of the investment?

No. While an eligible investment will growth tax free once held for 10 years, the limit to an individual OZF is 20.5 years. (2)

Q. What are the risks associated with investing in an OZF?

Mercer outlined in their Opportunity Zones whitepaper (accessible to CAIS Members below). Briefly, their paper outlines the following risks;

  • Development: due to strict development guidelines, managers will need to have development experience and local relationship, in addition to skills in acquisition and transactions.
  • Quality: not all Opportunity Zones share the same relative attractiveness. There is likely going to be strong competition for the best quality opportunities.
  • Property Value: property prices will likely increase in response to the large anticipated capital inflows.
  • Supply of Capital: significant capital inflows may cause Opportunity Zones to be overdeveloped leading to inflated prices.
  • Exit-timing: the full tax benefits of the program will be realized after 10 years, after which time there could be a large capital outflow which could put downward pressure on prices. (2)

1. Internal Revenue Service – IRS.Gov
2. Mercer White Paper: Opportunity Zones, 2019
3. Economic Innovation Group – EIG.Org
4. Grant Thornton – Understanding the Benefits and Challenges of Opportunity Zones

The opinions expressed in the reprinted article are those of the author, and do not purport to reflect the opinions or views of CPWM, LLC, its affiliates, or any of their respective employees. Full disclaimer found here.

Source: CAIS, Nicholas Millikan

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