Opportunity Zones (OZ), first proposed in the bipartisan Investing in Opportunity Act, were originally introduced in Congress in 2016 and designed with a specific premise — to encourage private investment in communities struggling to attract capital, create jobs, and lift residents out of poverty.
The Opportunity Zone program was subsequently created and enacted by Congress in the Tax Cuts and Jobs Act of 2017. In brief, OZs provide federal incentives for certain types of long-term, productive investments in low-income urban and rural communities nationwide.
So, what are the benefits for OZ investors?
Those who invest capital gains into a Qualified Opportunity Zone Fund (QOF) are eligible for the following benefits if they meet the holding period requirements.
- Defer —Capital gains can be deferred until Dec. 31, 2026, with the related tax payable in 2027.
- Reduce — Investors who hold an OZ investment for five years can exclude 10% of the deferred gain (i.e., they only pay tax on 90% of the gain). To receive this benefit, an investment must be made on or before Dec. 31, 2021.
- Pay zero — Investors who hold their investments in OZs for at least 10 years face no taxes on any appreciation in value of the investments when sold.
Two key components to assess when identifying an OZ investment are eligibility and timeout dates. Here is where a consultation with a tax professional can confirm you are making a Qualified Opportunity Zone investment.
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First, assess eligibility by confirming you will be investing a capital gain or qualifying Section 1231 gain. In terms of investment amounts, OZ investments provide flexibility that other tax-advantaged real estate investments do not. OZ investors can invest all or a portion of their gain, it’s up to them.
To enhance OZ investments and remain in compliance, keep track of the many relevant dates. Some dates apply to all OZ investors, such as when certain benefits expire. One benefit set to expire shortly is the 10% step-up in basis, which ends Dec. 31, 2021. Second are dates around the timing of when an OZ investment must be made. The general rule is that you have 180 days from the sale date or capital gain, with special rules applicable to gains that flow through to an investor via a Schedule K-1.
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Depending on the type of sale and how the assets are owned, there are consequences to timing. Discuss timeout dates with a tax professional who can help you understand this complex component.
Remember, OZ benefits are only available to investments of capital gains with a properly filed deferral election. While you can invest in an OZ project even if you aren’t deferring capital gains, the investment would be treated like any other investment.
To date, most OZ investment opportunities have been in the real estate asset class. Typically, OZ investment opportunities take the form of diversified QOF or single-asset direct QOF investments.
- Diversified funds aggregate investor capital and deploy it across different assets, creating diversification and decreasing risk for the fund and its investors.
- Single-asset direct QOF investments allow investors to invest directly into a pre-identified asset — and the investment gives the QOF and investors an ownership position in that single asset.
There are some opportunities available for OZ investors to invest in businesses and funds that in turn invest in businesses, but those investment opportunities have been less common and haven’t seen as much activity as real estate. And while qualifying for the 10% basis step-up is an incentive to make an OZ investment by Dec. 31, 2021, finding a long-term investment that fits within your overall investment strategy may be more important.
For more information on OZ investments, contact Jack Rybicki at [email protected] or 813-384-2701. For more information on CliftonLarsonAllen LLP, visit CLAconnect.com.