This column is offered to help educate agents new to commercial and investment brokerage and serve as a review of basics for existing practitioners.
A part of the tax bill that became law at the end of 2017 was the “Investing in Opportunity Act,” which established the Opportunity Zone program. The idea was to create incentives to revitalize economically distressed communities using private funding not taxpayer dollars.
Governors of all 50 states, U.S. possessions and the District of Columbia were given until April, 2018 to nominate qualifying census tracts in their jurisdiction that met the IRS requirements for designation as low-income distressed communities. Up to 25% of the census tracts in each area that met these requirements could be nominated. In June, 2018 the U.S. Department of the Treasury certified 8,700 tracts as Opportunity Zones, 12% of all census tracts in the U.S.
Developers and investors may form partnerships or corporations in the U.S. to invest in these locations by creating an “Opportunity Fund,” which must invest at least 90% of its holdings in one or more Opportunity Zones. Investments are limited to new construction or substantial improvement of existing unused buildings.
Tax benefits: A taxpayer can defer or eliminate capital gains taxes by investing in a qualified Opportunity Fund within 180 days of that asset sale. They would defer having to pay the capital gains taxes on that sale until December 31, 2026 or until they sell their Opportunity Fund investment – whichever is earlier.
If the investor holds their Opportunity Fund property for at least five years, prior to December 31, 2026, their deferred capital gains tax liability will be reduced by 10%. If the investor holds their Opportunity Fund property for at least seven years, prior to December 31, 2026, their deferred capital gains tax liability will be reduced by 15%.
If an investor holds their Opportunity Fund property for 10 years the appreciation from this investment is excluded from capital gains taxes.
Example: In 2019, an individual investor sells a building that results in a capital gain of $1 million. Instead of paying the $200,000 (20%) in federal capital gains tax on this sale, the investor rolls their $1 million gain into a Qualified Opportunity Fund that invests the capital in building project for new housing in an Opportunity Zone, with a plan to liquidate the fund in 2029. The assumed value of this investment when sold in 2029 is $2.2 million.
The benefits include: Being able to invest the full $1 million, (instead of the $800,000 that would be remaining if the capital gains tax were paid on the asset sale in 2019), into an Opportunity Fund.
Paying $170,000 in taxes in 2026, (by holding the property for seven years and having the capital gain reduced by 15%), instead of paying $200,000 in 2019. By holding the Opportunity Fund property for 10 years there will be no capital gains taxes owed on the appreciation of $1.2 million in capital gains on the Opportunity Fund investment when sold in 2029; saving $240,000 in taxes.
The best part of the Opportunity Zone program is the benefit, that when property is held for 10 years or more and then sold, the appreciation from these investments is excluded from capital gains taxes.
This also encourages pure investment without selling an asset. Real Estate Investment Trusts (REIT’s) and other qualified entities are being established to raise funds to invest in these Opportunity Zones. In NYC, Sky Bridge-EJF Opportunity Zone REIT was launched on Dec. 1, 2018 to raise capital from “small” and large investors. The minimum investment in this REIT is $100,000. This type of structuring opens opportunities for many people to take advantage of the Opportunity Zones, with the communities where they are located reaping most of the benefits.
There are many approved Opportunity Zones in the tristate area; NYS has 514, N.J. has 169 and Connecticut has 72. As these areas are revitalized with new housing and commercial businesses, the anticipated value of the new and redeveloped buildings in these areas is likely to increase. This program will also create many jobs and benefit the real estate industry.
Edward Smith, Jr., CREI, ITI, CIC, GREEN, MICP, CNE, is a commercial real estate consultant, instructor and broker at Smith Commercial Real Estate, Sandy Hook, CT.