Opportunity Zones – A Good Investment?
The Opportunity Zones that were created by the Tax Cuts and Jobs Act have generated a fair amount of buzz in the legal, accounting and real estate communities and have raised questions on application to 1031.
An Opportunity Zone (OZ) is an economically distressed census tract. OZs are designed to provide tax incentives to investors with the stated purpose of getting the private sector involved to spur economic development and job creation in distressed communities. These areas are in need of assistance. Over half the communities eligible for designation as Opportunity Zones had fewer jobs and fewer businesses in 2015 than in 2000.
Unfortunately an investment in an OZ fund cannot be structured as a 1031 Exchange. An investor can neither identify an OZ fund as a Replacement Property in a 1031 Exchange, nor utilize a 1031 Exchange when an OZ fund is sold. Since OZ funds are not real estate – they are Qualified Funds structured as corporations or partnerships – they are not eligible to be Replacement or Relinquished Property in a 1031 Exchange.
Assume a capital asset sold in 2018 for $150X with a capital gain of $100X. Within 180 days the $100X is invested in an OZ fund.
As with any investment, there are risks. Accordingly, it is essential that a potential investor seek the assistance of competent legal, tax and financial advisors to help them evaluate whether an OZ fund is a good investment for them.
Opportunity Zones can be broken down into three components:
- Investments - Opportunity Funds make equity investments in businesses and business property in Opportunity Zones
- Funds - Opportunity Funds are investment vehicles organized as corporations or partnerships for the specific purpose of investing in qualified Opportunity Zones.
- Zones - State and territories nominated 25% of their eligible low-income census tracts as Opportunity Zones.
To qualify for deferral:
- Capital gains must be invested in a QOF (Qualified Opportunity Fund) within 180 days.
- Taxpayer elects deferral on Form 8994 and files with its tax return.
- Investment in the QOF must be an equity interest, not a debt interest.
Opportunity Zone Tax Incentive:
- If a taxpayer holds its QOF investment at least five years, the taxpayer may exclude 10 percent of the original deferred gain. If a taxpayer holds its QOF investment for at least seven years, the taxpayer may exclude an additional five percent of the original deferred gain for a total exclusion of 15 percent of the original deferred gain.
- The original deferred gain – less the amount excluded due to the five and seven year holding periods – is recognized on the earlier of sale or exchange of the investment, or December 31, 2026.
- If the taxpayer holds the investment in the QOF for at least 10 years, the taxpayer may elect to increase its basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged. This may eliminate all or a substantial amount of gain due to appreciation on the QOF investment.
If you would like to find out more about how Opportunity Zones work, please give Exclusive Financial Resources a call at (980) 242-2533, email Louis Herford at Louis.Herford@ExclusiveFinancialResources.com or schedule a 15-minute discussion here.