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An Opportunity Zone is an economically distressed urban or rural community that has been identified by certain local, state, and federal qualifications. Additionally, localities can qualify as Opportunity Zones if they have been previously nominated for the designation by the state. If the localities have been nominated, then they will need to be certified by the Secretary of the U.S. Treasury.
The tax legislation surrounding this relatively new type of tax advantaged program may be a bit confusing. We do know that taxpayers can exclude or postpone taxes on capital gains that come from investing in a qualified Opportunity Zone fund, should the fund be held for at least 10 years. This means that both investors and syndicators can benefit from investing in Opportunity Zones. Finally, there are currently over 8,700 designated Opportunity Zones within the United States.
Opportunity Zones are relatively new! The first set of opportunity zones, covering parts of 18 states, were designated on April 9, 2018. opportunity zones have now been designated covering parts of all 50 states, the District of Columbia and five U.S. territories.
The government is providing certain opportunity zone tax benefits that wouldn’t normally be available to real estate investors. Here are the top tax benefits associated with investing in Opportunity Zones .
The first tax benefit that investors can enjoy is a temporary deferral of inclusion in taxable income. This deferral is only applicable for capital gains that are reinvested in an Opportunity Fund. Additionally, the deferred gain must be recognized before the opportunity zone investment expires or before December 31, 2026.
The second tax benefits that investors can enjoy is a step-up in the basis for capital gains that are reinvested in an Opportunity Fund. It is important to note that the basis is increased by 10 percent should the investment in the Opportunity Fund be held by the taxpayer for at least five years. If the investment is held for at least seven years, then the basis will increase by an additional five percent. The step-up basis increase can help investors exclude up to 15 percent of the original gain from taxation.
The third tax benefit that investors can enjoy is a permanent exclusion from taxable income on capital gains from the sale or exchange of an investment in an Opportunity Fund. Assuming the initial investment is held for at least 10 years. It’s important to note that this exclusion only applies to gains accrued after an investment has been made in a Qualified Opportunity Zone.
Did you know that U.S. investors currently hold $2.3 trillion in unrealized capital gains? These unrealized capital gains represent an untapped resource for further economic development and investment possibilities. Opportunity Funds allow investors throughout the United States to use their untapped resources for Opportunity Zone investments. The Opportunity Zone program is designed to incentivize long-term real estate investments via the following stipulations:
Any capital gains realized by an investor within 180 days before an Opportunity Fund investment, are still eligible for the tax benefits of investment in Opportunity Funds.
For many years, savvy real estate investors have used the 1031 Exchange for its tax efficient benefits. However, Opportunity Zones are strategically designed to reward long term investments by deferring capital gains taxes. Investors are able to defer their unrealized capital gains by reinvesting the monies earned into an Opportunity Fund. The investors are then taxed on only 85 percent of the original investment, as well as proceeds (if they decide to stay in the fund for up to seven years). If the investment is held for more than 10 years, then the investors are only responsible for paying taxes on the original investment. Holding onto the investment for more than 10 years is often the more cost effective option.
To further understand the tax benefits of 1031 Exchanges (or like-kind exchanges), it’s important that real estate investors understand the associated rules.
To further understand the differences between Opportunity Zones and a 1031 Exchange, we’ve conducted a side by side comparison looking at the following factors: rollover, qualified assets, investment structure, capital gains tax referral, capital gains tax reduction, and capital gains on final sale.
How do you decide which option is right for you and your investment strategy? Answering this question is easier with the help of a trusted investment advisor, CPA, or financial consultant. However, to help you get started, consider following a few guidelines:
Real estate can offer many unique benefits, including tax advantages. Working with a real estate expert can help you determine the type of real estate assets, and tax-deferred vehicle you should use to maximize your investment opportunities.
Are you interested in investing in an opportunity zone? If so, consider investing in a Qualified Opportunity Zone Fund. Keep in mind, Qualified Opportunity Zones will remain effective through December 21, 2028.
A Qualified Opportunity Fund is a U.S. partnership or corporation that will invest at least 90 percent of its holdings in one or more Qualified Opportunity Zones. There are three types of investments that can qualify:
Real Wealth Network is excited about this new investment opportunity, available to our members. We believe that real estate investments offered under Opportunity Funds can provide new advantages that are not available in most other real estate investments. Remember, there are certain requirements and certifications that Qualified Opportunity Funds must meet. Some of these requirements and certifications include:
To become a Qualified Opportunity Fund, an eligible corporation or partnership can use the self certification process. To self-certify, a corporation or partnership must complete the required form and attach that form to their federal income tax return. The return with the attached form must be filed within the established timeline.
Despite the many benefits that Opportunity Funds offer to investors, there are always risks associated. The key to mitigating associated risks is to remain diversified, while still taking advantage of the capital gains tax relief available through the program. On the other hand, if investors stay diversified, then there might not be enough funds flowing into these vehicles.
Corporations or financiers interested in investing in an Opportunity Fund should consider if the program’s new developments and investments in local businesses will spark revitalization in a low-income community. This will help determine if investors may reap a windfall. Additionally a single investor will likely not have enough capital gains to make an Opportunity Zone project work. Pooling funds from multiple investors may be necessary, which may create additional issues of governance and possible challenges for investors.
The following questions can further clarify the ins and outs of Opportunity Zones.
#1. How were Opportunity Zones created?
The Tax Cuts and Jobs Act created Opportunity Zones on December 22, 2017.
#2. Have Opportunity Zones been around a long time?
The short answer is “no.” The first set of Opportunity Zones were designated on April 9, 2018. To date, Opportunity Zones have since been designated to cover areas within all 50 states, the District of Columbia, and five U.S. territories.
#3. What is the purpose of Opportunity Zones?
At their core, Opportunity Zones are an economic development tool. They are strategically designed to spur both economic development and job creation in distressed urban and rural communities throughout the country.
#4. What is a Qualified Opportunity Fund?
A Qualified Opportunity Fund is an investment vehicle. It is setup to be a partnership or corporation, and used to invest in eligible property that is located within a Qualified Opportunity Zone.
#5. Do I need to live in an Opportunity Zone to take advantage of the tax benefits?
The short answer is “no.” To enjoy the tax benefits, you need to invest a recognized gain in a Qualified Opportunity Fund. Next, you will need to elect to defer the tax on that gain.
#6. I am interested in forming a Qualified Opportunity Fund. Is there a list of Opportunity Zones available in which the Fund can invest?
The list of designated Qualified Opportunity Zones in which a Fund may invest can be found at Notice 2018-48.
For more information on Opportunity Zones, please visit: https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions
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