You may have heard the term Opportunity Zone recently in conversation -- but what are they?
By definition “added to the tax code in 2017, an Opportunity Zone is an economically-distressed community where new investments, may be eligible for preferential tax treatment.”
After the recession, a disparity emerged, with some communities thriving and others who never fully recovered. Many of the latter have become opportunity zones. These zones are approved by the federal government and remain opportunity zones for 10 years after designation. During that time, investors can defer taxes on capital gains as long as they invest those gains into an opportunity zone fund. These funds must put at least 90% of the pooled capital toward developing, generating and operating businesses in the opportunity zones.
This incentive has spurred interest from CRE clients because of the increased investment opportunities and the guarantee that if the investment is held for at least 10 years, the appreciation on the opportunity zone investment is excluded from future taxation.
Now that you know the definition of an Opportunity zone, here are 3 things you need to know about investing in one.
When should I invest?
Now. Opportunity zone investments are attractive to investors because of the promise of tax deferment and exclusion. However, the tax reduction benefits are directly related to the amount of time the investment is maintained. If the opportunity zone fund is maintained for 5 years, there is a 10% exclusion for the deferred gain. In 7 years 10% turns to 15%.
Additionally, if the investment is maintained for a minimum of 10 years the investor becomes eligible for an increase in basis of the fund’s investment equal to its fair market value on the date that the fund investment is sold or exchanged. So the sooner you invest, the more quickly your investment can begin working for you.
Where should I invest?
Since there are designated opportunity zones in every state, you may wonder where the best place to invest is. It’s important to remember every community has different needs. A rural community may need industrial development support, where an urban area may need more jobs to support the shortage of affordable housing. As an investor, it is important to choose with this in mind. You can find opportunities everywhere, but familiarity with an area where you have experience may be a good place to start when deciding where to invest.
How should I invest?
When it comes to investing in opportunity zones, you may want to think about broadening your traditional ideas to put your capital gains to work. Investors may not usually think to diversify their portfolio with assets that may yield a lower return. However, opportunity zones shake things up a bit. The tax benefits allow investors to take a lower pre-tax return on a diverse asset and end up receiving a higher post-tax return. This allows new projects in areas that can greatly benefit from the expansion.