The Opportunity Zone tax incentive, enacted into law as part of the Tax Cuts and Jobs Act of 2017, is intended to deliver transformation to low-income areas throughout the country, many of which have been left behind since the Great Recession. Governors of every U.S. state and territory were able to nominate up to 25 percent of their low-income and high-poverty census tracts as Opportunity Zones. There are plenty of maps available to identify an Opportunity Zones. But be careful, investors have already fallen into errors in buying a property that did not end up being designated an Opportunity Zones despite a faulty map. Accordingly, check multiple sources and at least the U.S. Treasurer’s website, which specifically lists out the approved census tracts.
The investment vehicle that must be used to invest in Opportunity Zones are termed as a “Qualified Opportunity Fund”. These funds are self certified through a form to the IRS which require basic information such as the (i) the type of entity (corporation or partnership), (ii) certification that the purpose of the fund is to invest in Opportunity Zones, and (iii) investment certification of the qualified assets in Opportunity Zones versus non-qualified assets not in Opportunity Zones. Accordingly, the investment structure is relatively simple and extremely flexible allowing everything from individual investors to REITs into the Opportunity Fund world.
With the ease of self-certification, we can expect to see single-purpose entities being used for such tax deferral without the need to structure a complex real estate “fund” that comes with the connotation. Regardless, at least 90% of the capital in these Opportunity Funds must be invested in Opportunity Zones.
Investor Tax Incentives
Ultimately the benefit of Opportunity Zone program is the deferral of taxes until 2026 (or the sale of the investment in a Opportunity Fund if before 2026). Furthermore, if the investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain and if held more than 7 years, the 15%. If the investment is held for at least ten years, the investor is eligible to increase the basis of the investment to its fair market value on the date it is sold or exchanged.
Be cautious that taxes will still be due in 2026 even if you hold the investment for 10+ years. An investor will pay tax on some portion of that original gain in 2026, so the hope for an investor is that the corporate bylaws or partnership agreement provide for adequate distribution models that provide funds (if available) to at least pay these tax liabilities.
To be a qualified fund asset in the Opportunity Fund, the investment must be an eligible equity investment into a business in an Opportunity Zone or in the real estate, provided that the basis is doubled within 30 months. Additionally, certain “sin businesses” are not permitted. These include golf courses, country clubs, massage parlors, hot tub facilities, tanning beds, racetracks, casinos and liquor stores.
Other requirements exist and keep in mind final regulations are still being formed and are subject to change. For example, other requirements include restricts on how much of the assets may be held in cash or that the property actively conducts business.