What is an Opportunity Zone?
In the tax cuts and jobs act, opportunity zones across the United States were established. Opportunity zones are areas designated by governors and confirmed by the US Treasury as low-income areas experiencing economic hardship relative to the rest of the country. The idea behind them was to incentivize private investment as opposed to government funding into these areas by offering tax benefits to investors. Currently, there are more than 8,760 opportunity zones designated across the country.
Tax Benefits
Investing in opportunity zones allows investors to defer and lower any capital gains taxes in most situations. Most capital gains are eligible to be invested in opportunity zones. Both short- and long-term capital gains relating to the sale of stocks, bonds, property, or interest in a partnership are eligible to be invested into opportunity zones. By investing the capital gains, the capital gains taxes owed are deferred until either the sale of the opportunity zone investment or until December 31st, 2026. There are some exceptions and rules. There is a 180 day period in which the capital gains from the sale of an investment must be re-invested into an opportunity zone for the taxes on the capital gains to be deferred. Also, some capital gains relating to derivative contracts and capital gains from a sale or exchange to a related party are not eligible. A related party is one with whom you have a 20% direct or indirect relationship.
In addition to the deferral of the capital gains tax, if the investor holds the opportunity zone investment for at least five years, then only 90% of the capital gains that the investor used in the opportunity zone investment will be eligible for taxes. For example, say an investor puts $1,000,000 of capital gains into an opportunity zone investment. They hold the investment for 5 years, then whenever they sell the fund or when December 31st, 2026 comes around, only $900,000 of the original $1,000,000 will be taxed at the current capital gains tax rates, a 10% reduction to the amount of taxable gains. There is an additional reduction of 5%, to a total of a 15% reduction, to the capital gains that can be taxed if the investment is held for seven years, but now December 31st, 2026, will come before that is possible for any investment made today. The risk here would then be an increased capital gains tax rate in 2026 relative to now, but the lowering of the amount to be taxed after five years by 10% provides some protection to increased rates.
Lastly and arguably, the most significant tax benefit from investing in opportunity zones is that if the investment is held for ten years or more, then any capital gains relating to the investment into the opportunity zone itself are not eligible for taxes. This is what can really boost the real return from these investments relative to other options. Using our previous example, say $1,000,000 in capital gains was invested into an opportunity zone today and that asset was held for ten years and then sold for $2,000,000. On December 31st, 2026, while the investment was still being held, taxes on $900,000 of the original $1,000,000 in capital gains would be due. After the asset was sold, the $1,000,000 in capital gains from the investment into the opportunity zone would be tax-free.
How to Invest in Opportunity Zones and Real Estate Development
To invest in opportunity zones and be eligible for the tax benefits, funds, and capital gains must be invested through an opportunity zone fund. While there are many of these funds around, it is easy for anyone to form one and have control over the opportunity zone investments. An opportunity zone fund must be set up as a corporation or partnership and can be created by filing a form 8896 from the IRS. To remain qualified, an opportunity zone fund must hold 90% of its assets in an opportunity zone area. Qualified investments include real estate/property, equipment, and businesses that get at least 50% of their income from an opportunity zone. When the fund purchases a real estate, substantial improvements must be made to the property in 30 months or less. Improvements are considered significant when they are equal in cost to the original value the fund paid for the asset. There are several businesses, including golf courses, liquor stores, country clubs, gambling establishments, and some other recreational facilities that cannot be invested into by opportunity funds. Funds are reviewed every six months and at year-end to ensure compliance. Recently it was said that opportunity zone funds with less than 90% of their assets in opportunity zones would not lose their status but would be subject to penalties.
The rules, regulations, and benefits relating to opportunity zone investment and funds are still adjustable by the government, so it would be wise to consult a professional before acting on any related investment.
Titan Pacific Group is here to help you achieve the best results in real estate. Investing in real estate in opportunity zones is one of the many ways we can help our clients achieve their goals. We rely on our experience and market expertise to drive performance for our clients.
Call us at 949-464-7639 for more information on Opportunity Zone investing in Orange County, San Diego, and Los Angeles.
Sources:
https://www.fool.com/millionacres/taxes/complete-guide-real-estate-opportunity-zones/