Opportunity Zones are an economic development tool that allows people to invest in distressed areas in the United States created under the Tax Cuts and Jobs Act of 2017 (Public Law No. 115-97). Their purpose is to spur economic growth and job creation in low-income communities while providing tax benefits to investors. There are thousands of low-income communities in all 50 states, the District of Columbia, and five U.S. territories are designated as Qualified Opportunity Zones.
There are three main benefits of Opportunity Zone Investing:
- Temporary Gain Deferral: A temporary deferral in taxable income for capital gains that are reinvested into a qualified opportunity fund (QOF). The deferred gain must be recognized on the date of investment disposal or on 12/31/2026, whichever is earlier.
- Partial Forgiveness: A step-up in basis for capital gains reinvested in a QOF with increases for investments held longer. There a potential for up to 15% credit if held at least 7 years with distinct time restrictions.
- Permanent Exclusion: A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in a QOF if held for 10+ years.
- Taxpayer: Any individual or entity that can recognize gains on their federal income taxes that invests in a QOF investing in designated QOZs in qualified property(ies)/business(es).
- Qualified Opportunity Fund (QOF): An investment vehicle that is set up as either a partnership, LLC, or corporation for investing in eligible properties or businesses that are located in a QOZ.
- Qualified Opportunity Zone (QOZ): QOZ are low-income census tracts nominated by state governors and certified by the US Treasury. Benefits for investing in QOZs include: 1) Deferral of capital gains invested until 12/31/2026. 2) Reduction in capital gains taxes invested in QOF. The cost basis on the original capital gains invested in an QOZ fund can be stepped up. 3) Exclusion of gain on qualified opportunity zone property held for at least 10 years.
- Qualified Business (QB): A domestic business where 90% of QOF assets are invested in an QOZ for the life of the business, and the majority of the business is conducted and revenue generated from within the QOZ.
- Qualified Property (QP): Tangible property used in the trade or business of a QOF where 70% must be used in the QOZ during 90% of the QOF’s
As a real estate investor, you must be set up in a way that would require you to pay federal income tax on capital gains. Eligible gains for QOZ investing include short, long, and 1231 (real or depreciable property held longer than 1 year and used in a trade or business).
Those gains must be placed in a Qualified Opportunity Fund (QOF) and those funds must be then invested within the appropriate timeframes in a Qualified Opportunity Zone (QOZ) into Qualified Opportunity Property (QP). That property must then be doubled in basis.
There's a simple IRS tax form Form 8996 (PDF) to set up the fund.
In some ways, it behaves similarly to a 1031 exchange. You have a set time to identify the investment and a timeframe you must finish. Unlike an exchange, however, an investor must double the basis of a property. The goal of QOZs is an investment in low-income areas so this is a key part of what must be accomplished and also well documented in case of an audit.
Also, unique to QOZ investing is the ability to move gains from investments like stocks into real estate. A 1031 exchange requires like-kind investments. So, if you're selling a single-family rental, the 1031 exchange will require exchanging into some other physical form of real estate. With a QOZ investing, an investor can cash out of things like Tesla stock and move those gains into real estate via the QOZ process!
Please seek counsel from your CPA when dealing with Qualified Opportunity Zone investing. Remember you get the most benefit from holding the qualified opportunity zone investment for 10 years. An investor has the ability to set this up as individuals or invest gains into a 3rd party fund investing in QOZ activity. With a 10-year timeframe, it's critical to do some long-term planning and understand how to gain the most benefit from this tool.
To rehabilitate, re-develop and re-vitalize communities that once thrived but may have lost major employers. This requires commitments from local governments, etc.