As the year moves on, the clock for the tax benefits received through qualified Opportunity Zone investments is winding down quickly.  We recently shared a few posts on our blog relating to Opportunity Zone investments for professionals and investors to help educate them on the potential benefits and risks within. 

The following article shares additional insights on this topic. It was written by one of our colleagues, Tim Witt, who serves as Director of Research and Due Diligence Officer for Concorde Investment Services, LLC, Fortitude’s broker-dealer.

The article reviews the potential benefits of OZ’s for investors and how important it is for advisors to understand if (and when) these investments make sense for a client.

To paraphrase Tim’s article from February 25, 2019 with our included insight:

The Tax Cuts and Jobs Act passed by Congress in December 2017 included many changes to the tax code. One was the creation of "Opportunity Zones": state-designated and U.S. Treasury-approved areas where "new investments, under certain conditions, may be eligible for preferential tax treatment."

Opportunity Zones are specifically designed to incentivize investments in economically distressed communities. These designated areas create an opportunity for investors to receive some intriguing and potentially significant financial benefits.

It is critical that advisers fully understand the rules, procedures, and timelines involved when recommending opportunity zone investments to their clients. While opportunity zones offer significant tax benefits, there are limitations that may affect some investors decision to proceed.

Broadly speaking, the opportunity-zone provision allows investors to temporarily defer capital gains tax with a potential 15% increase in basis. There are some similarities between the timing & tax benefits of opportunity-zone investments and those available under a 1031 exchange. Investors using a 1031 Exchange can defer capital gain and depreciation recapture taxes from a property sale if they reinvest the proceeds in a replacement property or in a DST (Delaware Statutory Trust).   Although they are similar there are some significant differences as well.

While a 1031 exchange only permits tax deferral on the sale of real property, opportunity-zone benefits apply to a range of assets such as, real estate, the sale of a business or highly appreciated stock. This allows the opportunity zone investments to appeal to a wider range of investors.

Opportunity zone real estate developments may offer a higher internal rate of return than investments in existing stabilized assets, but the nature of a development project means that investors aren't likely to receive any cash flow for the first few years of the investment.

Additionally, after the initial deferral, investors have an opportunity for two modest step-ups in basis: 10% if the investment is held for five years and 15% after seven years (if the five- and seven-year periods end prior to Dec. 31, 2026).

If the investment in the project is held for 10 years, however, the investor may elect to increase their basis to allow no capital gains or depreciation recapture taxes on that investment. This makes the longer-term IRR potential for opportunity zones, both pre- and after-tax, look attractive, but investors with liquidity needs or flexibility preferences inside of that 10-year time horizon should think carefully. The suitability for an opportunity-zone investment should be evaluated on an investor-by-investor basis.

While there's no limit on how many 1031 exchanges an investor can execute — preserving the ability to continue deferring taxes until death — the initial gain deferred upon an investment in an opportunity zone becomes payable on Dec. 31, 2026.

Certain product sponsors plan to return some capital through the refinancing of a project's construction loan to help with tax payments. Nonetheless, investors should keep enough liquid assets available to pay future taxes and not rely on a potential sponsor distribution. Additionally, opportunity zones allow 180 days to reinvest, do not require a qualified intermediary & can be funded from any source as long as a gain was recognized, , they can be a great option for investors who missed the chance for a valid 1031 exchange.

Advisers and investors alike should be careful not to let the tax tail wag the investment dog. Evaluate the quality of every investment independently, and don't make any decisions solely for tax benefits.

But for investors who have realized a substantial gain (and incurred a substantial tax bill), opportunity zones provide a chance to reinvest and allow those assets more time to have a chance at appreciating— an appealing alternative to writing a large check to the government.

You can read Tim’s original article here.

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DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million dollars exclusive of primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are risks associated with investing in real estate and Delaware Statutory Trust (DST) properties including, but not limited to, loss of entire investment principal, declining market values, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. The information herein has been prepared for educational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA). Fortitude Investment Group is independent of CIS, CAM and CIA, all of whom are unaffiliated with third-party sites, cannot verify the accuracy of, nor assume responsibility for any content of linked third-party sites. Information available on third-party sites is for informational purposes only.