President Trump recently directed several federal agencies to focus on spending in certain opportunity zones in order to encourage development in those areas. What are these opportunity zones, and how can real estate developers and investors use them to increase their portfolios and take advantage of the promised tax breaks?
What is an Opportunity Zone?
Last year, Congress passed the Tax Cuts and Jobs Act, which created the opportunity zones that the president is now beginning to focus on. The idea is to encourage long-term investment in low-income communities in order to revitalize those communities and reinvigorate the economy. The program allows real estate developers an opportunity to reinvest their capital gains into such communities and projects while receiving tax benefits for doing so.
Opportunity zones exist in every state in the union, the District of Columbia, and five U.S. territories. That gives state and local governments and economic agencies incentive to help promote them, which makes sense because real estate is an intrinsically local business.
In choosing which communities to call opportunity zones, Congress established an eligibility baseline based on poverty rates and median family income but tasked state governors with nominating the individual communities to be designated for these zones. Doing it this way allowed state governors, who are accountable to the people in their states, a stake in the economic outcome of the initiative. Being closer to the ground, so to speak, governors would have better insight and deeper knowledge into the economic realities of the communities being considered.
To learn more about opportunity zones, visit the Economic Innovation Group at https://eig.org/opportunityzones.
Who is Eligible for Tax Breaks in Opportunity Zones?
It’s important to note that tax incentives are not offered across the board for all opportunity zones. Eligibility is based on the nature of the capital used for these developments.
In order to receive a tax benefit from investing in opportunity zones, a developer must use capital gains as equity reinvestments through a special purpose opportunity fund that is eligible for the tax benefit. That’s very important because many developments use multiple streams of financing. While it is fine to use multiple streams of financing for these developments, developers must understand that only qualified capital can be used to gain access to the tax benefits.
An opportunity fund is a specific type of investment vehicle structured as a partnership or corporation. To receive the tax benefit in question, the fund must invest in eligible properties within eligible opportunity zones.
Currently, capital gains can be deferred depending on how capital is tied up in a qualified opportunity fund up to 15 percent if held for more than seven years.
How To Know Which Opportunity Funds and Opportunity Zones Qualify
The U.S. Treasury Department in conjunction with the Internal Revenue Service has issued a set of guidelines for developments on proposed regulations and guidance on the tax benefits associated with opportunity zones. Along with the guidelines, they have published a spreadsheet that lists qualified opportunity zones. Developers can also access a map of designated qualified opportunity zones in the same location. You can find these on the Community Development Financial Institutions Fund website. As the program is further developed, we should see more guidance and more solid regulations regarding opportunity funds and opportunity zones.
Opportunity funds and opportunity zones promise real estate developers tax deferrals for helping to spur development in economically disadvantaged neighborhoods all across the country. When these neighborhoods are revitalized, it should boost local economies and continue to spur development for many years to come.
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