Within the last year, investors have been presented a new type of opportunity. Much like a 1031 Exchange, that helps to shelter taxes, the creation of Qualified Opportunity Zones (QOZ) is a modern version of the exchange. Let’s call it the 21st Century version of the 1031 Exchange.
The 1031 Exchange has long been a great tax incentive for real estate investors. Now, with the establishment of QOZs, investors have a way to “defer and decrease their initial and/or potential capital gains tax. QOZs, also offer a way to eliminate any capital gains taxes earned from their Qualified Opportunity Fund (QOF) investments under certain conditions,” and adherence to milestones along a timeline.
With the passage of the Tax Cuts and Jobs Act of 2017, signed on December 22, 2017, which was the most sweeping tax legislation since the Tax Reform Act of 1986 was signed into law, Opportunity Zones were added to the tax code.
In 2018, QOZs were rolled out across 18 states, with all fifty states—including D.C. and Puerto Rico—eventually featuring these new investment opportunities. As of December 2018, data shows over 8,700 Qualified Opportunity Zones across the nation.
What is an Opportunity Zone?
In short, they are areas in economically distressed regions that have been designated to spur economic development by providing tax benefits to investors. By deferring taxes on gains made through these investments in a Qualified Opportunity Fund (QOF), they offer a new vision and tool for investors to deploy capital in a tax deferred environment.
According to the IRS, here’s how the deferments work:
Investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026.
If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain.
If held for more than 7 years, the 10% becomes 15%.
If the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.
The below chart courtesy of Fundrise better exemplifies milestone incentives a Qualified Opportunity Zone offers:
Why Should I do This?
Much like the 1031 Exchange that has particular tax benefits for investors, these new Opportunity Zones will provide similar benefits, with a key difference: holding onto the property benefits you more. Time is your friend; the longer you hold onto a Qualified Opportunity Zone, the more benefits you accrue.
By investing in economically distressed zones, the investor can make an impact through either demolition or redevelopment of these under serviced areas, providing a benefit to all who are involved in the property.
It’s really a win, win position to be in. Whether or not it’ll spurn economic development is yet to be seen. However, with the tax incentives surrounding QOZ, it’s a worthwhile endeavor and investment.
If you have any questions how Opportunity Zones affect you or your investments, please call the Alpha-Rex team to discuss and answer questions on any property or portfolio needs you have.