[REN #611] Opportunity Zone Floodgates Ready to Open

Picture of apartment building with fire escape for Real Estate News for Investors Podcast Episode #611

Investors are poised to pour billions of dollars into Opportunity Zones across the country. The government program is part of the Tax Cuts and Jobs Act to generate investor interest in targeted, mostly lower-income, communities. In return, investors who use capital gains to fund the investment will get a huge tax break. It’s similar to a 1031 exchange, but much better in some ways.

What is an Opportunity Zone?

An Opportunity Zone, or “Ozone” as some people like to call them, are low-income census tracks that are lagging behind other more prosperous U.S. communities. The governors of each state were allowed to designate 25% of those low-income tracts as potential Opportunity Zones to help promote investment in those areas. They were also allowed to designate 5% of adjoining tracks that meet less stringent poverty level requirements. (1)

For low-income Ozones, the poverty rate must be at least 20% with a median family income that’s no more than 80% of the area median. For neighboring tracts, the median family income is limited to 125% of the low-income census tract next door.

Once areas were identified by local governments, they were submitted for approval to the U.S. Department of the Treasury. As of now, there are around 8,700 “Qualified” Opportunity Zones within the U.S. and its territories.

As a territory, Washington, D.C. nominated Puerto Rico, and the entire island is now an Opportunity Zone. Puerto Rico was already insolvent when Hurricane Maria struck last year and devastated the island. (2)

What is an Opportunity Fund?

The program also created a new kind of investment vehicle for Ozones called Opportunity Funds. They must be organized as a corporation or partnership that’s specifically geared toward Ozone investment.

Ninety percent of the funds must be put into Qualified Opportunity Property, and they are limited to equity investments in real estate, businesses, and business assets. They must also be certified by the U.S. Treasury.

How Do Investors Benefit?

So here’s the good part… Investors who roll the capital gains from the sale of an investment into a fund, or deposit the gains into a fund within 180 days, can realize a big tax benefit. It’s done on a stepped up basis so gains that are invested longer, reap a bigger tax savings.

Here are the basic rules:

  • If the investment is held for at least 5 years, the investment basis is increased by 10%, which reduces the value of the capital gains by 10%. Tax is paid on just 90% of the original amount.
  • If the investment is held for 7 years, another 5% is added on to the basis, and tax is paid on 85% of the capital gains.
  • Waiting another three years will yield the best results. If the investment is held for 10 years, the basis on the new investment will be equal to the market value of the property at the time of sale or exchange which reduces capital gains, and taxes, to zero. However, tax on the original gain must be paid by 2026 – at least that’s what we’re hearing now. Nothing is finalized quite yet.

 

Opportunity Zones vs. 1031 Exchange

If this sounds somewhat similar to a 1031 Exchange, it is, but with some amazing fringe benefits. When you do a 1031 Exchange, you must re-invest the entire amount of the sale, including both the basis and the gain, into a similar property. That’s not the case with an Ozone investment. You can take just the gain, and put that into an Opportunity Zone Fund. That will defer any tax on the gain, and leave the investor with the rest, as cash in hand.

And for Ozones, you can use gains from any kind of investment, not just real estate. It doesn’t have a “like-kind” requirement, so you can use gains from stocks, bonds, or other parts of your investment portfolio. The timeline is also more generous for Opportunity Zones. You only have 45 days to identify a replacement property for a 1031 Exchange, and 180 days to fund that investment. For an Opportunity Zone property, investors simply have 180 days to re-invest their gains.

Opportunity Zones also allow for pooled funds that can invest in several assets. A 1031 Exchange can also exchange one property for multiple properties, but they have to fall within the like-kind rules. Tax payments are deferred indefinitely for the 1031, which is a good thing for investors who want a long timeline. Opportunity Zones have a shorter timeline (the original tax on the gain must be paid by 2026), but there is an opportunity to completely eliminate taxes on the new gain from the new property if you hold on to your investment for at least 10 years. Again, those details have not been finalized.

What Are We Waiting For?

You can see why this new government-sponsored program is creating so much excitement among investors, including us at RealWealth. While some economists are predicting that investors will pour $50 billion to $80 billion into the program, Treasury Secretary Steven Mnuchin believes it will attract 100 billion investment dollars.

According to a blog in Bisnow, the original architect of the program, Steve Glickman, has spoken to hundreds of investors who are all anxious to put their money into Ozone projects. Glickman says, “We always knew this would be a larger incentive than any previous community investment program, but I think the actual market demand and interest is way higher than even I thought earlier this year.” (3)

The one thing that’s holding investors at bay for the moment, are final tax rules from the IRS. Bloomberg says, they are currently with the Office of Management and Budget’s Office of Information and Regulatory Affairs. They go back to the IRS from there. Bloomberg says the IRS is expected to release them by the end of this month.

Timeline for Investing

Once that happens, expect the investment floodgates to open as fund managers try to meet a December 31st, 2019 deadline.

One interesting thing that we’ve discovered is that some of our favorite rental markets are located in those census tracts, giving our members even more reason to add new investment properties to their portfolios.

We’ll be learning more about these Ozone investments this weekend at our live events in San Mateo, Los Angeles, and San Diego.

Links:

(1) Opportunity Zone FAQs: IRS

(2) Where are Opportunity Zones?

(3) Bisnow Article

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