Opportunity Zones | What You Need to Know
Last week Revolve Capital attended the IMN Opportunity Zones (Midwest) in Chicago.
The conference discussed Opportunity Zones surrounding the Tax Cuts and Jobs Act of 2017. Opportunistic zone areas include neighborhoods infected by factors such as distressed mortgages, lost jobs or boarded up neighborhoods. By building in these areas, investors can actually retain their capital gains tax instead of paying it to the government. What exactly are opportunity zones, who can invest in them and how can you benefit from these incentives?
What are opportunity zones?
According to the IRS, the Tax Cuts and Jobs Act (TCJA) is a “Major tax legislation that will affect individuals, businesses, tax exempt and government entities”. The Act added the IRS Code of 1986, which essentially effects multiple major taxed sectors: individuals, estates, business taxation, corporate tax, churches and nonprofit organizations, distressed communities, and more.
Opportunity Zones are defined as “economically-distressed communities where new investments, under certain conditions, may be eligible for preferential tax treatment”. These qualified zones were “created by the 2017 Tax Cuts and Jobs Act. Designed to spur economic development and job creation in distressed communities throughout the countries, they provide tax benefits to investors who invest eligible capital into these communities.”
Who can invest into these zones?
These opportunity zones are open to every private investor that has the sophistication and wherewithal, who knows how to structure their fund based on the rules and limitations of the Jobs Act, and who would like to tap into the opportunity zone revenue dollars and concurrently defer capital gains taxes. Historically, these types of opportunities were sometimes available only to accredited investors (typically requiring a net worth of $250-500K+) to invest in these projects. The Qualified Opportunity Zones program can be utilized by investors on any end of the spectrum… whether you are a private investor, a small investor, a new investor or a larger seasoned investor, you can benefit from the advantages of building in these areas.
Note, there are special reporting requirements. Reporting ensures the restabilization of the distressed area is being pursued.
How can investors benefit from these types of investing opportunities?
If you are interested in diversification into other asset classes or are already diversified, then investing in opportunity zones might be a revenue stream you should explore. Sectors such as commercial, strip malls, communities, hotels, gas stations, land, homes, etc. can take part in building in the distressed zones. By looking for ways to invest dollars to A) avoid capital gains taxing and interest from the IRS to be retained into your projects; and B) seeking to find a way to help revitalize these opportunities (by purchasing acres for housing development, revamping strip malls, creating gas stations and hospitals, etc.) you can play a part in this economic development tool. Revolve Capital has product (both non-performing and re-performing loans) located across the nation, many assets being directly located in these areas of opportunity.
By utilizing alternative asset class diversification, our investors can segue way into putting single-family home investments into the fund. Meanwhile, making these areas livable, appealing and fundamentally opportunistic. In return, we can expect an influx of first time home buyers, renters, borrowers, and families. When you create charming up-and-coming neighborhoods filled with Walmarts and Targets then people will be incentivized to move there, filling the demand of customers.
There is a big crossover between building in opportunity zones that lasts between 7-10 years and economic growth of communities that have been boarded up, people have moved out, building has been condemned. Communities that might have previously been more attractive, had a larger population, and where investors and developers were once putting their investment dollars. That is the crux of the message… that these opportunity zones create a number of different ways to invest into single-family homes, commercial properties, land, etc. in terms of both long-term and short-term benefits. Now that we are 11 years removed from one of the biggest crisis since 1929, you can tell banks, lenders, communities, developers, builders are not interested in those areas. The government is creating an opportunity to go back to these areas and develop.
Revolve Capital has continued to be at the forefront of revamping communities. Our firm and many of our investors purchase homes that are pre-foreclosure all the while helping families avoid foreclosure altogether.
What are the disadvantages?
While anyone can benefit from investing in these areas, the only way to qualify for the tax incentives is by purchasing the investment through a qualified opportunity fund. EIG.com released information explaining “You cannot simply purchase real estate in an opportunity zone, there has to be improvement to the property to ensure it meets the qualifications of the investment and providing economic stimulation. Additionally, the Fund must invest at least 90% of their assets in a qualified Opportunity Zone.”
According to the Economic Innovation Group, Opportunity Zones incentives are “tied to the longevity of an investor’s stake in a qualified Opportunity Fund”. They continue on explaining…
“There are three core tax incentives:
Temporary deferral: A temporary deferral of inclusion in taxable income for capital gains reinvested into an Opportunity Fund. The deferred gain must be recognized on the earlier of the date on which the Opportunity Zone investment is disposed of or December 31, 2026.
Step-up in basis: A step-up in basis for the deferred capital gains reinvested in an Opportunity Fund. The basis is increased by 10% if the investment in the Opportunity Fund is held by the taxpayer for at least 5 years and by an additional 5% if held for at least 7 years, thereby excluding up to 15% of the original deferred gain from taxation.
Permanent exclusion: A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in an Opportunity Fund if the investment is held for at least 10 years. This exclusion only applies to gains accrued on investments made through an Opportunity Fund. There is no permanent exclusion possible for the initially deferred gain.”
Essentially, if you choose to invest in qualifying opportunity zones your capital could be tied up for 7-10 reducing additional opportunities to invest in a variety of other asset classes.
The Opportunity Zones is a step in the right direction for the government to stimulate economic growth in underserved areas; however, our company firmly believes it is more advantageous for investors to focus on preforeclosed assets. There is not a requirement to hold a distressed note investment for an extended period of time if it is not providing the expected return, you have the option of investing in any nationally located area, and most importantly you can still revamp communities by choosing to keep families in their homes
For a more passive income stream that provides economic stimulation, potential growth for lower income distressed neighborhoods and multiple exit strategies we suggest considering notes for your future investments. Contact us today to learn more information on how we can help you grow your portfolio.
Sources:
Economic Innovation Group (2019), Opportunity Zones FAQs
Retrieved from: https://eig.org/opportunityzones/faq
IRS (2019), Tax Reform
Retrieved from: https://www.irs.gov/tax-reform
IRS (2019), Opportunity Zones Frequently Asked Questions
Retrieved from: https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions