Capital gains from investments such as real estate, precious metals, stocks, and bonds or the sale of a business are all subject to state and federal taxes, which investors are keen to defer or avoid altogether.
A great way to reinvest capital gains while avoiding heavy taxes is through the Opportunity Zone Program. Such programs exist to promote economic growth by providing tax breaks on investments in distressed areas.
Regulations for Opportunity Zones
There are three main regulations that define an opportunity zone and understanding them is key to an investment in these areas. They are as follows:
First, a qualified opportunity zone (QOZ) can invest in designated “Opportunity Zones” that were enacted into law in 2015 by the federal government. Opportunity Zones were nominated typically in low-income or underserved community that would benefit greatly from private investment.
According to the IRS, there are 8,764 QOZs that will retain that status for the next decade. QOZs nominated by governors must have a 20% poverty rate and average family income that is less than 80% of the median income in that area. Investment in these areas, if done correctly through a Qualified Opportunity Zone Fund, can not only benefit the community greatly but affords incredible tax advantages for the QOZ Fund and its investors.
A qualified opportunity fund (QOF) as mentioned above, is the entity that invests funds into a QOZP. Investors must use a QOF to handle the transactions to qualify for the tax benefits offered by the Opportunity Zone Program (1).
Importance of Opportunity Zones
Opportunity zone investments offer benefits to both investors and communities. Investors in a QOZ Fund can diversify into portfolios that positively impact the people they serve while gaining financial and tax benefits along the way. Your investment of any amount of capital gains in any QOZ also opens up new opportunities for investors.
Communities also receive the boost they need to reduce unemployment, inequality, and crime and improve education, healthcare, housing, and other innovative solutions. Solid investment in building and infrastructure development is currently struggling communities recover from the impacts of the Covid-19 pandemic.
Tax Benefits from Opportunity Zones
The key benefit for investors is deferring capital gains taxes for five, seven, or 10 years or longer. If the QOZ Fund holds the investment for five years, the basis for the original investment increases by 10%, and an additional 5% if held for seven years.
Gains from properties held for 10 years or more will have their taxes eliminated altogether when they sell or exchange the properties.
General Tips for Investing in Opportunity Zones
The first thing to note is that a QOZ Fund is the only means of investing in an opportunity zone. Investors can register the fund either as a partnership or corporation for this purpose, or they can choose an existing fund in the zone of their choice.
The QOZ Fund holds 90% of the assets and must also earn at least half of its income from within the zone itself. Investors don't have to live within the QOZ, so due diligence is necessary beforehand.
You should also consider the market characteristics of the QOZs. A QOZ Property should ideally be close to transit hubs, have good private and commercial rental rates, and recreation and education opportunities for long-term portfolio planning. You can read more about how location ultimately affects a commercial real estate investment here. The stronger the market fundamentals, the more likely the success of the investment.
Finally, since there are many legal requirements and compliance regulations governing opportunity zones, investors should consult an experienced tax advisor and real estate expert with a good track record to make the best returns on their investments. At Fortress, we have several investments in opportunity zones and the professional know-how to guide you through the process. For more information, contact us!