Buried deep within the new ‘2017 Tax Cuts and Jobs Act’ is a tax incentive for investment in qualified Opportunity Zones. This may be the single most significant wealth building opportunity for anyone realizing capital gains from the sale of real estate, stocks, bonds or even a business. Perhaps the equivalent of the 1031 exchange rules on steroids, it offers not only a tax deferral on the capital gain, but also a tax reduction and permanent tax exemption on the new investment.
Each state can designate a quarter of its eligible low-income communities as Opportunity Zones under the Tax Act. Qualified Opportunity Zones are intended to encourage investments that will be used to start businesses, develop abandoned properties or provide low-income housing in distressed communities. Under the program, taxpayers are able to invest their capital gains into a third party Qualified Opportunity Fund or a self-directed Fund within 180 days of recognizing the capital gain, thereby deferring the tax on the capital gain to December 31, 2026. The longer the funds stay invested, the larger the tax savings. This tax incentive is intended to help “areas in need of redevelopment” attract capital.
• An equity interest in an entity that is a US corporation, partnership or LLC that is a Qualified Opportunity Zone Business. During substantially all of the time that the Qualified Opportunity Fund holds the equity interest, the entity must qualify as a Qualified Opportunity Zone Business which cannot include golf courses, country clubs, massage parlors, hot tub facilities, racetracks or other facilities used for gambling, or any stores where the principal business is the sale of alcoholic beverages for off premise consumption; and
• Tangible property (real estate) acquired by a Qualified Opportunity Fund after December 31, 2017 which is substantially improved. Property is treated as substantially improved only if the capital expenditures made with respect to the property in the 30 months after its acquisition by the Opportunity Fund exceed the purchase price for the property. Property does not qualify as a Qualified Opportunity Zone Property if it is acquired from a related person (20% or more commonly owned entities).
• The first tax benefit is the tax deferral. The capital gain from the sale of a qualified asset is deferred until December 31, 2026, at which time the tax must be paid.
• If the Qualified Opportunity Zone Property is held for five years, the taxes due are reduced by 10%. This increases to 15% if the investment is held for seven years.
• If the investment is held for 10 years or more, the investor is entitled to a step-up in basis to the investment’s FMV at that time so any appreciation in the value of the investment can be excluded from income.
To date, there has been very little guidance from the IRS on exactly how the Opportunity Zone provisions will work. The IRS has announced a self-certification process for establishing Opportunity Zone Funds by simply attaching a self-certification form to the fund’s first-year tax return. The IRS will be providing further guidance covering the rules regarding the treatment of debt and whether investment partnerships can invest their capital in stages to match the development cycle. The next big question is how each State will treat investments in Opportunity Zones for State Tax purposes.
The bottom line is that an investment in an Opportunity Zone Property not only provides tax benefits, but if the investment is made prudently with a sound business and or development partner, it can prove to be a diversified wealth building tool.
Progress Capital is working with clients who own properties in Qualified Opportunity Zones. If you have a capital gain or plan to realize a capital gain, give us a call and we can guide you to the right investment opportunities as well as professionals (legal and accounting) who are well versed in the rules regarding Opportunity Zones. Alternatively, if you are a commercial real estate owner with a project in an Opportunity Zone, we may be able to help you with debt and equity to realize your development goals.
Kathy Anderson is the Founder and Managing Partner of Progress Capital, a leading Commercial Mortgage Banking firm specializing in arranging debt and equity for commercial real estate owners and residential developers. Since 1990, Progress has successfully closed in excess of $40 Billion in commercial loans and deployed over $150 Million through their direct lending platform. Kathy serves on the Board of Directors at Regal Bank located in Livingston, NJ, has been retained as an expert legal witness in commercial real estate litigation, and is a featured speaker at industry conferences.