Invest in Opportunity Zone?

Question

Hi,

Has anyone in this forum invested in Opportunity Zone? If so, in what state? What pros and cons and precautions you would advise others?

My strategy is to buy and hold long term investor.

Thanks for your advice in advance!

Chris Montgomery · Answer

@Joanne Tsai @David M.

A couple of points of clarification on the above comments.

1)  You can invest capital gains or non capital gains into an opportunity zone fund. However, as @Matthew Irish-Jones indicated, only the capital gains invested qualify for the tax incentives, so in practice for most people it doesn't make sense to invest non capital gains.  Why sign up for a 10 year hold when you don't get any of the tax benefits? The regs are explicit that non capital gains in a fund do not get any of the benefits, not even the capital gains avoidance on the sale after 10 years.

2) One of the comments above says: "I thought if one carries the investment property for more than 10 years in an opportunity zone, once the property is sold, one would not have to pay tax gain?”   This is only partly true. To get the capital gains forgiveness after 10 years, you have to invest into a Qualified Opportunity Zone Fund.  The Fund has to be structured properly and comply with all of the OZ regs.  It’s not enough to simply own property in a zone.

3) Another comment asks: “or the initial fund has to be from another real estate deal?”  No, the funds do not have to be from another real estate deal. To qualify for the OZ benefits you can invest capital gains from any source.  Short or long term gains that qualify as capital gains can be invested.

4) Another comment says: “There is probably still depreciation unrecapture.”  I’m assuming this was meant to say there is still depreciation recapture.  One of the often overlooked benefits of a QOZ fund that invests in real estate is that after 10 years when the properties are sold, you are NOT subject to depreciation recapture. This was only made clear in the final regs which came out in December.

I run an OZ fund. I’m not a lawyer but am happy to answer OZ questions.

@Matthew Irish-Jonesundefined

Destin Harris · Answer

@Chris Montgomery

Hello Chris, Do it matter the project you investing into ( ex. Theme Park, etc.) are do it have to be residential in the opportunity zone?

Thanks

Joanne Tsai · Answer

@Matthew Irish-Jones

I thought if one carries the investment property for more than 10 years in an opportunity zone, once the property is sold, one would not have to pay tax gain? or the initial fund has to be from another real estate deal?

Jeremy Bennett · Answer

This is all pretty confusing to a rookie investor.  My question: I sold a commercial property about 5 months ago.  Capital gains were about $30,000.  If I use this money to buy a multi-family home in an opportunity zone would I qualify for the tax benefits?   What steps do I need to take before buying the new property?  The new property costs $99,000 and will require about $20,000 to rehab and update.

Chris Montgomery · Answer

@Destin Harris  Sorry for the delayed response. You can generally invest into any type of project as long as it is in the zone and meets the requirements of the legislation. At it's simplest level that means complying with the substantial improvement test (spending at least 1 x the purchase price of the tangible asset excluding land costs) and the 50% revenue test for businesses.  There is also a list of precluded investments, known as “sin businesses,” that are not eligible for Opportunity Fund  nvestments.  These include operating a country club, golf course, massage parlor, hot tub facility, suntan facility, racetrack or other gambling facility, or liquor store. No specific exclusion on a theme park.

David M. · Answer

@Chris Montgomery

Thanks for the clarification!😉

Chris Montgomery · Answer

Both answers are close. The benefits are as follows:

1) If you invest capital gains into a fund, you get to invest tax deferred. The gains on your current taxes are due at the end of 2026 (paid in 2027)

2) When you've held the investment in the fund for 5 years, you get a 10% step up in basis. Your basis is originally set to zero, so the 10% step up in basis works out the same as a 10% discount on the amount you'll pay taxes on.  Ex:  If you invest 100k now, when you pay the taxes in 2027 you'll be taxed on a 90k gain.  Note: You will be paying the taxes at the capital gains rate that exits in 2026.

3) After a 10 year hold, the basis is set to market value.  When the asset is sold this allows you to avoid all capital gains and also allows you to avoid depreciation recapture.

As mentioned above, the zones were set on a state by state basis.  Many of the zones that were selected are indeed blighted, but there are also areas that have significant opportunity for investment.

David M. · Answer

@Steve Morris

The step up in basis is in year 10 with current law.  I believe in 5 and 7 years is a discount on the gains.

Steve Morris · Answer

In a OZ, the main goal is to encourage investment in blighted areas.  The state picks the areas and assumes the median incomes as a marker.  So you may find some downtown land.

However, major investment may mean almost razing the property and then getting an equity partner involved for the rehab.

What you'll get out in 6-7 years is a step-up in basis when you figure capital gains upon sale.

I guess it beats dying to get a step-up in basis, but I'd really look hard at the required improvements.

Chris Montgomery · Answer

@Tom Wagner   I'm obviously biased since I run an OZ fund, but I agree that it's a powerful tool for wealth preservation and creation. The tax benefits are massive as long as the underlying investments are sound.

The best resource for tracking legislation on OZs that I've found is at Novogradac.  Here is the link that can be filtered by topic:  https://www.novoco.com/news?page=1  It's always difficult to predict what will happen with future tax policy, especially in the current political climate. In spite of some bad press regarding a few zones that probably shouldn't have been included (Parts of New York City, downtown Portland, etc) and in spite of the OZ legislation being labelled as 'Trump' program, it genuinely is a bi-partisan program.  There are multiple bills that have been proposed by each party.  The only significant one that has been passed extends the 180 investment period through 12/31/2020 for anyone who's investment period would have ended between April and June.  We'll have to wait and see what happens politically for the rest of it.

Invest in Opportunity Zone?

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