Great timing…
We recently had a capital gain of ~1.5 million from selling a family business late November 2018. Our tax burden would have been around 500k and we were thinking about reinvesting the remaining million in ongoing real estate projects but with this we may be able to invest all $1.5 million in (albeit riskier probably) assets and win the tax game.
https://www.ncsha.org/resource/opportunity-zone-fund-directory/
Has a good list of funds.
This is new for our accountant, clocks ticking though, only have until mid May to pull the trigger. Will update!
I would be highly cautious if I were you. In my opinion, there is far too much capital chasing far too few viable opportunities. That’s going to A) drive the price up on the handful of truly viable projects, making the margins smaller and squeezing most of the value before they’re even started, B) cause funds to deploy capital into less desirable (read: higher risk) projects.
Furthermore, the requirements to qualify for the tax incentives are pretty stringent. To qualify you must:
1. Buy a property in an opportunity zone (Duh!)
2. Within 3 years, you must invest an amount equal to the basis of the building you are buying (For example you buy an apartment building for $5M, and the land is worth $1M, you must spend an additional $4M on redeveloping the property in the first three years you own it in order to qualify). This is a big hurdle. It also pretty much eliminates the ability to cherry pick the deals that are located in OZs, but are actually decent properties that are well located, because you’re going to have to dump such a significant amount of money into the project on top of a higher (relatively) purchase price.
3. Then after all that, in order to qualify for the entire tax incentive, you have to hold the property for at least 10 years.
So even if you can find a property that is viable, which is no small task, you now must also meet all of those requirements and tradeoffs (ten years of illiquidity? Yikes!).
I’ve posted about OZs on the forum and as someone who is made a living in CRE, I personally think that OZs are the most overhyped opportunity out there right now. I’d be very cautious about pursuing this, and quite frankly , I would highly advise against rolling your gains over into a fund. Those funds are going to have to deploy that capital regardless of whether there are enough viable opportunities available. If you’re bent on pursuing an OZ investment, I would do it as direct as possible, so you know exactly what project your money is going to rather than a general fund.
I’d be curious as to how expensive these funds are (expense ratios). Also, would these receive the same tax-inefficient treatment as traditional REITs?
These must be high risk investments to justify these kinds of tax incentives. Likely C & D class properties with all their associated risks. I won’t be investing in these anytime soon, but look forward to seeing how it pans out for those that do.
It makes absolutely no sense to sell real estate in order to roll it into an OZ. Just do a 1031, and you get all the benefits, but you can choose any property you want, anywhere you want, and there is no additional investment requirement, and you can sell it at any time (at which point you can do another 1031). The fact that an OZ fund is passive is not a benefit. There are plenty of ways to get passive income through properties that qualify for a 1031.
Even if you found a property that was the best investment you could find on the market and it just so happened to be in an OZ, it still doesn’t make any sense to sell another piece of real estate to invest in it (unless there were no other options). And if that’s the only option for raising the capital, then again, just do a 1031, avoid the investment requirements and 10 year lockup. Selling real estate in order to invest in an OZ is a non-starter.
I personally looked at some of these zones in California and not sure if it would be worth it. Risk of principal loss is huge for the minuscule possible gains. If such a location is on the path of progress then it does make sense. The high speed rail for example has been a non-starter so time frames for these investments would be much larger. Easier to invest overseas and get better gains.
Agree with CREguy on the tax basis comment.
I just met with Caliber and I have phone call with Origin tomorrow. Caliber owns some quality properties in Phx and Mesa OZ. What areas are considered “OZ” in phoenix , downtown Tucson and mesa also happen to be some of the fastest growing (I live in phx close to several). Did anyone decide to pull the trigger on this investment?
I was impressed by the properties Caliber has in their OZ fund independent of tax benefits to be honest. I believe the estimated IRR is 12-20% independent of tax benefits at Caliber. But, I have heard some say that you actually may be better served with individual property for an OZ investment so I’m looking at a single OZ investment sponsor as well (maybe due to difficulty liquidating so many in a fund after 10 years).
WCI, maybe u need to start a opportunity fund! Interested WCI-ites can contribute and we can have a great fund to work with. Then need to find an opportunity zone to start doing something in.
If you’ve been thinking about real estate investing, I’ll bet that you’ve heard a lot about the tax benefits. Well, there’s a recent benefit that has come to light that might allow you significantly minimize capital gains taxes on existing and future opportunities, while feeling like you’re doing some social good at the same time.
This is thanks to a state and federal partnership that provides tax incentives for investing in what’s called “Opportunity Zones.”
What are Opportunity Zones?
Opportunity zones are areas where the local government is hoping to promote economic growth. These areas are typically distressed due to closed industries, demographic changes, or other economic conditions.
With the assistance of local officials, each state’s governor selects census tracts to be included in an opportunity zone. The United States Treasury Department then certifies these zones for inclusion in a federal tax incentive program.
Again the goal of designated opportunity zones is to bring new businesses and development into these areas. This might be through new construction or through renovating existing buildings. It might also be through the creation of new businesses that serve that particular area.
Here’s an example of currently designated opportunity zones in Los Angeles.
Why Invest in Opportunity Zones?
Opportunity zones are a way to invest in areas that need an influx of attention and redevelopment. Because of the government’s involvement in trying to grow the entire area, those investing in opportunity zones will have government backing through policy and dollars. It might make you feel good knowing you’re helping to build a distressed community.
To entice investor participation in the project, the government has also thrown in significant tax incentives to seriously sweeten the deal. These tax incentives were part of the Tax Cuts and Jobs Act of 2017, effective beginning in 2018.
What are the Tax Incentives?
These tax incentives were created to encourage investors who have unrealized gains in their portfolio to “unlock” those profits and minimize the capital gains tax impact at the same time. This applies to a wide array of asset classes including real estate, public securities like stocks and bonds, and businesses.
There are three major tax incentives for participating in an opportunity zone.
1) Deferral of Capital Gains on Prior Investments
If you sell a property or an asset like a stock for a taxable gain and reinvest the proceeds into an opportunity zone within 180 days of the sale, you do not pay capital gains tax on those proceeds at the time of the transaction. Instead, the tax is deferred until you sell your investment in the opportunity zone or December 31, 2026, whichever comes first.
Example
Jim purchased $100,000 of XYZ stock 20 years ago and it has increased to $600,000 in value ($100k initial investment + $500k profit). He would like to sell all of his holdings but is looking for a way to minimize his tax burden.
So Jim decides to invest in an Opportunity Zone fund. He sells the stock and gets to take back $100,000 (his original investment and therefore not taxed). He also has a gain of $500,000 and invests it into an Opportunity Zone fund. He can now defer what he would’ve paid in taxes on that $500,000 profit until potentially as far as 2026, while that money is put to use. If he invested at the time of this article, that could be 8 years of tax deferral.
2) Reduction of Capital Gains
There’s an additional tax benefit where you might also be able to reduce the taxes owed on those deferred gains depending on how long you stay in the opportunity zone investment. Let me explain:
Example
Using the previous scenario, Jim has at this point deferred taxes on his $500,000 gain and kept it in an opportunity zone fund investment.
3) No Tax on Investments Greater Than 10 Years
The third and possibly best benefit is that if you hold your investment in an opportunity zone fund for at least 10 years, the tax basis of the property becomes equal to the selling price. In plain English, this means that you would not have to pay taxes at all on the gains of your investment in the opportunity zone…. NONE.
Of note, this only applies to the amount of deferred gain that you’ve reinvested into the opportunity zone. Any “fresh money” that you bring into the deal would be taxed at a normal capital gains tax rate.
Example
Jim invested $500,000 of rolled over gains into an Opportunity Fund Zone in 2018. He doesn’t have to pay taxes on these gains until 2026 at which point he pays taxes on $425,000 (instead of the original $500,000) because of the 15% reduction.
By year 10, his $500,000 investment has doubled to $1 million. He exits the fund and does not have to pay a single cent of capital gains tax on that additional $500,000 of profit.
How to Invest in Opportunity Zones
Sounds like a pretty amazing opportunity, doesn’t it? Well, it did to me. So I looked into how to actually invest in these opportunity zones. In short, opportunity zone investments must be in the form of funds that qualify under Treasury and IRS rules. You can invest with professionally created funds or you could create your own.
It seems like there’s a mad dash to create these funds because there is only so much real estate in these zones and based on the timeline of tax benefits, it makes sense for investors to jump into these things earlier rather than later to capture all of the available tax benefits.
These funds act like traditional real estate funds but invest entirely into properties located within opportunity zones. This gives you a passive way to receive the growth opportunities and tax benefits of investing in an opportunity zone.
In fact, I’m starting to see these funds pop up in many different places including some of the more popular real estate crowdfunding sites like EquityMultiple and Fundrise.
Am I Personally Going to Invest in an Opportunity Fund?
Would I sell some of my current property to invest in this fund? I definitely won’t be selling my apartment building for it. I might consider selling a single family if it appreciated enough to make it worth it.
I’d have to consider a 1031 exchange at the same time and see what made more sense. However, these opportunity funds are quite passive so the appeal is definitely there, plus all of the tax benefits.
Again, there are many opportunity zone funds out there, and I have to go through the same process that I do when I vet syndication or real estate funds. I’ll let you know if and when I do decide to invest in one.
Is an Opportunity Fund Right for You?
As you can see, investing in opportunity zones can allow you to reap the rewards of traditional real estate investing along with substantial tax benefits. To decide if an opportunity fund has a place in your diversified portfolio, carefully review the fund’s prospectus and consider talking to your tax and financial advisers.
There are other options for tax deferral including 1031 exchanges and some charitable trusts. Deciding which option works out best may require some calculations and discussion with your CPA.
Had you heard of opportunity zones before and do the tax benefits seem compelling to you? Comment below!
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