What Opportunity Zones Mean for Investors - Ideal REI

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opportunity zones

What Opportunity Zones Mean for Investors

So you just sold one of your stock or bond investments and now you’re about to get crushed with capital gains taxes, right?

Not quite…

You see, you still have options to defer or even completely eliminate those taxes using a new loophole in the system.

Let me explain.

Opportunity Fund Investing is a newly-minted tax-advantaged method of investing in real estate that will accessible to individual investors, not just institutional capital.

What are opportunity funds?

Opportunity Funds are a new tax -advantaged investment vehicles created as part of the Tax Cuts & Jobs Act of 2017. The concept was introduced as part of the Investing in Opportunity Act - a bipartisan bill that was included alongside the broader tax bill -but has received far less attention until now.

The goal is to help spur greater private-sector investment in targeted communities across the country called Opportunity Zones.

What are opportunity zones?

Opportunity Zones are designated census tracts selected by the state and federal governments for economic development. Opportunity zones can be found in every state and in urban, suburban and rural areas. These are areas that have historically been passed over by investment capital, and meet certain qualifications with respect to poverty levels and/or sub-median income levels.

Qualifying census tracts must meet a minimum threshold of its population living below the poverty line, and/or a max average income of 80% area median income. This hardly means, however, that these areas should be unappealing to investors.

Many of the opportunity zones already established are centrally-located infill neighborhoods in thriving metros that, while less affluent than their cities overall, already exhibit signs of economic vibrance and should continue to develop alongside the broader metro.

Examples of such opportunity zones are The Pearl and waterfront Old Town in Portland, Oregon; Downtown Oakland, California; Koreatown in Los Angeles; sections of the Lower East Side in Manhattan, and various close-in neighborhoods in the Outer Boroughs of New York City, including Downtown Brooklyn.

Elsewhere, wide swaths of cities experiencing a renaissance have also been designated as opportunity zones, including much of central Houston, encompassing demand drivers like the Port of Houston and various large biomedical employers; and virtually all of Detroit, including the rapidly revitalizing area around Wayne State University.       

Market fundamentals already support investments in many of these census tracts. This new system of tax incentives should make such investments all the more compelling.

Why invest in opportunity funds?

Qualifying investments offer three unique and compelling tax advantages - investors can defer paying federal capital gains from recently sold investments until December 31, 2026, reduce that tax payment by up to 15%, and pay as little as zero taxes on their Opportunity Fund investment if held for 10+ years.

Opportunity Fund investing also offers the chance to have material impact on the well-being of under-resourced communities. This presents the opportunity for individual investors to include real estate in their portfolio of “triple-bottom-line” investments - those that not only yield compelling returns, but also yield positive social impact.

Even if you’re only concerned with net returns, however, the tax advantages alone should pique your interest (more on that in a moment)...  

What kind of gains are eligible for tax deferral?

Investors may defer capital gains tax on any recently sold investment – including the sale of stocks, bonds or real estate – so long as those gains are rolled over into an Opportunity Fund investment within 180 days of sale.

Simply put, this new program for tax-advantaged investing is a sea-change in how investors are able to reduce capital gains tax, and carries the potential of funneling huge volumes of capital to communities across the country that need more affordable housing and more efficient access to equity for small business. If done well and with proper oversight and guidance from the Treasury Department, this may truly create win-win-win investments across the country.

But focusing strictly on net returns for a moment, consider what would happen if a $50k stock portfolio with 10% expected annual pre-tax rate of return were instead rolled into a qualifying Opportunity Fund over 5, 7, and 10 year time horizons:

  • 5 years: an additional $6,726 in net profits
  • 7 years: an additional $10,388 in net profits
  • 10 years: an additional $35,203 in net profits, or an equity multiple improvement from 2.69x to 3.39x over the lifetime of the investment.
opportunity zones investing

Of course, performance of Opportunity Funds will vary (just as other assets do). For more on the potential return impact of Opportunity Fund investing, and more detail on where Opportunity Zones are, please visit {insert link for EM Oppty Zone page}

1031 Exchange vs Opportunity Zone Fund

Yes and no. Both programs allow real estate investors to roll over sale proceeds from an asset and thus defer paying capital gains tax, but they differ in some important ways.

1031 Exchanges allow for deferral of taxation, whereas Opportunity Fund Investing allows for not only deferral of taxes paid on a preexisting investment by rolling over proceeds into an Opportunity Fund, but also a) the opportunity to reduce the tax basis on that preexisting investment after 5 or 7 years and b) the opportunity to pay no capital gains tax on profits realized through the Opportunity Fund.

While 1031 Exchanges can be a valuable tool for more hands-on real estate investors, Opportunity Fund Real Estate Investing provides much more flexibility. Whereas 1031 Exchanges can only be used for ‘like-kind’ rollovers into a similar real estate asset, stocks or other assets can be rolled into Opportunity Funds. 1031 exchanges are designed for single-asset swaps; one property.

Multi-property funds may be eligible, but structuring the exchange typically carries additional fees and complexity. Conversely, Opportunity Funds can invest in a pool of real estate assets within qualifying opportunity zones, or gains from a preexisting investment could be rolled into fractional investment in various Opportunity Funds via platforms like EquityMultiple, allowing for diversification.

and New Market Tax Credits (NMTC’s) were designed for institutional investors, whereas Opportunity Zones allow individuals to more readily access tax-advantaged real estate investing. If you invest fractionally in an Opportunity Fund or an eligible Opportunity Zone real estate asset through a platform like EquityMultiple, you would see the same tax benefits as conferred upon the developer or sponsor.

Doing Well by Doing Good

This presents a true opportunity to “do well by doing good” - because the new tax regime requires that funds be held in a qualifying investment for 10 years to receive the lion’s share of the benefit, the program ensures that funds will remain allocated to under-resourced communities for long enough to make a true difference.

Many markets in the U.S. are suffering from an acute affordable housing shortage. This exciting new program affords individual investors the chance to invest in the revitalization of neighborhoods across the country, while potentially earning very compelling after-tax returns. 

About the Author Andrew Schmeerbauch

Andrew is the Content Director at Clever Real Estate, a St. Louis based startup offering to sell your home with flat fee real estate agents. Most of his work can be found on the Clever Real Estate Blog and other real estate publications.

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  • Carly West says:

    Very informative! This really does represent great opportunity for new investors. It’s also a great example of why it’s so important to always stay up to date with the latest property news and initiatives.

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