Opportunity zones were set up by the Tax Cuts and Jobs Act of 2017 to increase economic development in distressed areas. Individuals start by setting up a "qualified opportunity fund," and then invest in a property located within a "qualified opportunity zone."
What are opportunity zones?
The Opportunity Zone Program is a plan offered by the federal government to drive development to economically distressed areas. Corporations receive tax incentives in exchange for investing in areas that might have otherwise been overlooked.
Zones have designated census tracts that qualify as low-income communities. Governors in each state are responsible for identifying census tracts that are eligible for the Opportunity Zone Program.
Opportunity zones must follow an exact certification and nomination process. To qualify, each tract must meet one of the following requirements:
- A poverty rate of 20%.
- Average family income lower than 80% of the median income in that area.
According to the NCL, more than 8,700 opportunity zones have been identified across all 50 states for the next 10 years.
What are qualified opportunity funds?
If you’re interested in this investment opportunity, your first step is to set up an organization for investment zone properties. This is what’s known as a qualified opportunity fund, and it’s the vehicle you’ll use to invest in opportunity zones.
A qualified opportunity fund must hold 90% of the fund’s assets in either zone property stocks, partnership interest or business property. The fund can be any size and can apply to one property or multiple properties across several different states.
Opportunity zones can create positive growth through creating new jobs and improving educational opportunities.
How does the program work?
The opportunity zone program is designed to spur economic development in struggling communities through private investments rather than taxpayer funds. And to encourage private investors to participate, the government offers several tax incentives.
To get started, you need to invest the proceeds from the sale of an asset into a qualified opportunity fund. You can use the proceeds from any appreciated asset, but the investment must take place at least 180 days after the sale.
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The benefit to distressed communities
The goal of the opportunity zone program is to create a positive impact in distressed communities. Opportunity zones can spur economic growth in one of the following ways:
- Creating new jobs.
- Reducing unemployment.
- Reducing crime.
- Reducing inequality.
- Improving education opportunities.
Before investing in an opportunity zone, it’s helpful to take some time to understand the needs of that community. This knowledge will help you have the greatest impact.
What are the tax benefits?
Here are the three tax benefits investors will receive for investing in an opportunity fund:
- Defer capital gains taxes: When you invest in an opportunity zone fund, you can temporarily defer capital gains taxes. Unless you sell or exchange the interest, the IRS won’t recognize any gains until December 31, 2026.
- Step-up in basis: If the investment is held for a minimum of five years, the basis is increased by 10%. If the investment is held for at least seven years, the basis is increased an additional 5%.
- Eliminate taxes on future gains: Investors who hold the asset for at least 10 years can eliminate their taxable income on capital gains from the sale or exchange of the fund.
Things to keep in mind
Investing in an opportunity zone is a way for investors to help disadvantaged communities while receiving valuable tax breaks. But the complexities of the program and legal jargon used in the tax code can be intimidating for new investors.
If you’re trying to decide whether investing in an opportunity zone is right for you, here are a few things to consider:
- Compliance is key: Compliance is crucial if you want to make the most of this investment opportunity. Your investment must be held in a qualified opportunity fund, and it must be set up as a partnership or corporation for tax purposes.
- Consider the market you’re investing in: Make sure the market fundamentals are strong before investing in an opportunity zone. Otherwise, the tax benefits won’t matter.
- You can invest in an existing fund: Another thing to keep in mind is that you can either create your qualified opportunity fund or invest in an existing fund. If you choose to invest in an existing fund, take the time to learn more about the experience of that team and their track record.
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