The federal Opportunity Zone program offers significant tax incentives to taxpayers who invest in land-use, business or real-estate projects within specified low-income and underserved communities. Investors with the right strategy and long-term investment goals can take advantage of this program to reduce, or even eliminate, their capital gains taxes.
As a real-estate attorney with Holmquist + Gardiner, I specialize in transactions involving mixed-use development properties and tax-deferred investment strategies, including Opportunity Zone investments. I help clients mitigate risks and successfully take advantage of incentives.
The Opportunity Zone tax deferral program was devised to spark significant financial and community benefits, but there are restrictions that a taxpayer should consider before committing capital investment through the program. If you’re becoming acquainted with this tax program for the first time, it’s important to understand the inherent sense of urgency and the procedural steps that must be followed. For now, potential investors find themselves in a window of opportunity. But it won’t last forever.
The Opportunity Zone program was included in the federal Tax Cuts and Jobs Act of 2017. The 2017 Act directs the governor of each state to designate up to 25 percent of the state’s eligible, low-income census tracks to become Qualified Opportunity Zones (QOZ). These zones are found in all 50 states and cover downtown metropolises, industrial zones, suburban and rural areas. For a quick reference, the Washington State Department of Commerce website lists the designated Opportunity Zone tracts selected by Governor Jay Inslee.
Understanding the Mechanisms that Make Opportunity Zone Investments Work
Due to the particular framework of the program, we find it helpful to think about an Opportunity Zone investment in the form of a timeline. Here’s a breakdown of how the tax deferral program works:
After a taxpayer recognizes capital gain from a share of stock, a real-estate transaction or a partnership interest, the taxpayer can identify the right opportunity and invest that capital gain equity in a Qualified Opportunity Fund (QOF). These funds are organized as a corporation or partnership – that means no direct property investments by a sole proprietor. Funds can be coordinated by a single LLC, a partnership or a billion-dollar corporation. As soon as that capital gain is realized, a countdown begins: You have 180 days to make an initial investment in a QOZ property.
Once the equity investment enters the Opportunity Zone Fund, the fund must hold 90 percent of its assets in Opportunity Zone property. Routine, bi-annual IRS filings prove that you are following the directives. Penalties are levied for failure to comply.
Let’s start the clock:
30 Months after QOF Investment:By the 30-month investment mark, you must “substantially improve the property.” The language is somewhat loose, but if you don’t double your basis, you lose your status. An Opportunity Zone investment’s purpose is economic development, not speculation. The same red flags can arise if a QOF contains too much property in the portfolio.
5 years after QOF investment: If you retain interest in the fund for 5 years, 10% of your capital gains won’t be taxed
7 years after QOF investment: You benefit by another 5% reduction in capital gains taxes.
10 Years after QOF investment: You receive zero capital gains taxes from the sale of your interest in the fund, as long as you invest by 2037.
Note that the 7-year deferral of taxes only lasts until December 31, 2026, so potential investors need to invest by December 31, 2019 if they wish to reap the full benefits of the federal government program. In addition to the future cutoff from benefits, there are limitations to how qualified investments can be used. Certain business investments don’t qualify, like golf courses or liquor stores. Tangible property used in business associated with the fund, like heavy equipment machinery, must remain within the Qualified Opportunity Zone boundaries. These are just a few examples.
Government incentives work. An examination of the Mortgage Interest Tax deduction shows a clear line of sight to the rise of the single-family homeownership market. The development of 401K’s helped spark a retirement investment market. Opportunity Zones are a structured incentive that can generate significant investments where the influx of capital is needed most.
The talented attorneys at Holmquist + Gardiner are experts at counselling investors on how to mitigate risk when entering into any real-estate or property investment. We understand the complexities of federal, state and local laws that impact sound financial strategies. We value your individual objective and work with you accordingly in a prompt and cost-effective manner.
If you have questions on a current Opportunity Zone investment, or one in the making, reach out to an attorney on our team and contact us today.