The Opportunity Zone (OZ) program was enacted in 2017 as part of the Tax Cuts and Jobs Act. The OZ program provides investors with powerful tax incentives to commit capital to America’s underserved communities. The 8,764 original Opportunity Zones are low-income census tracts from 2010 identified by local governments in partnership with the U.S. Treasury.
The legislation incentivizes investment in these neighborhoods by enabling investors with taxable gains to defer and reduce those gains through reinvestment in real estate and businesses in those communities.
The Opportunity Zone (OZ) program legislation established the Qualified Opportunity Fund (QOF) as the investment vehicle for OZ investing. As described by the IRS:
A Qualified Opportunity Fund is an investment vehicle that is organized as a corporation or partnership for the purpose of investing in Qualified Opportunity Zone property (other than another Qualified Opportunity Fund). To certify and maintain a Qualified Opportunity Fund, an entity must:
1. File a federal income tax return as a partnership, corporation, or LLC that is treated as a partnership or corporation;
2. Be organized for the purpose of investing in Qualified Opportunity Zone property under the laws in one of the 50 states, the District of Columbia, a U.S. possession, or a federally recognized Indian tribal government; and
3. Hold 90% of its assets in Qualified Opportunity Zone property.
The OZ program got off to a slow start when it was rolled out due to several ambiguities in the original legislation. But following two rounds of subsequent IRS clarification rules, Opportunity Zone investments accelerated as reflected in a recent GAO report:
The Government Accountability Office reported in October 2021 that preliminary IRS data for tax year 2019 showed that nearly 18,000 taxpayers were invested in more than 6,000 QOFs [Qualified Opportunity Funds are the designated structure of OZ investing], which collectively held almost $29 billion in qualified property. - forbes.com; April 25, 2022
The original legislation offered several enticing tax deferral benefits for investors including, the ability to defer, reduce and potentially eliminate future capital gains taxes due on the sale of any asset type such as stock, art, a business, personal residence, bitcoin, etc.
The popularity of the OZ program has prompted legislators on both sides of the aisle to extend the program. On April 7, 2022, congressional leaders submitted bipartisan, bicameral legislation (sponsored by both parties in the House and the Senate), to enhance and extend the tax benefits of the Opportunity Zone program. The result is the ”Opportunity Zones Transparency, Extension, and Improvement Act.”
Defer Capital Gains
Once investors realize a taxable gain, they have 180 days to reinvest their eligible gains in a QOF. Then, they can defer recognizing the gain, under current tax law, until December 31, 2026 (with any tax payment due on April 15, 2027, when the taxpayer files a return).
Under the proposed tax law revision would extend the deferral period two years until December 31, 2028.
Reduce Capital Gains
Early investors in QOFs benefited from a potential step-up in basis of up to 15% on their reinvested gains. Last year in 2021, the step-up in basis was 10%, but the benefit expired on New Year’s Eve. A step-up in basis reduces realized gains and thus taxes due.
The new legislation gives investors a second chance. Under the updated OZ legislation, investors who roll their eligible realized gains into a QOF by the end of 2022 and hold their investment for at least six years will receive a 15% step-up in basis on December 31, 2028. Those who invest next year, by December 31, 2023, and hold their investment at least for 5 years will receive a 10% step-up in basis.
Eliminate Future Capital Gains
OZ investors who hold their investment for 10 years or more will pay no capital gains tax on the appreciation of the new investment. We believe this original benefit of the OZ program may prove to be the most productive of all.
Altogether, OZ investors can potentially enjoy enhanced after-tax returns through capital gains tax deferral, reduction, and future elimination.
Congress is also making technical changes to enhance the OZ program:
$1 Billion Local Dynamism Fund
Congress will add a $1 billion state and community fund to support projects in lower-income communities with extra technical assistance and financing.
Feeder Funds and Funds-of-Funds
The OZ program will now allow feeder funds and funds-of-funds, a benefit to smaller investors and investors seeking diversification.
Early Sunset for Some OZs
The legislation will require an “early sunset” of certain middle-income census tracts from the OZ program. These tracts were included in the program based on 2010 census data (or were contiguous to certain eligible census tracts), have already seen economic improvement, and are “graduating” from the program. Current investments in these middle-income census tracts will be grandfathered.
Reporting, Transparency, and Oversight
The success of the OZ program depends upon data. Investors will need to provide more substantive reporting on their activities, a provision of the original legislation dropped in the budget reconciliation process in 2017. This will expand program transparency and oversight.
To learn more about Opportunity Zones, feel free to schedule a call with our team today! You can also learn more by downloading our latest ebook, Tax-Advantaged Investing: The Power of Private Real Estate:
Because investor situations and objectives vary this information is not intended to indicate suitability for any individual investor.
This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
Certain QOZ areas may not be able to appreciate as predictably as more established areas. Some neighborhoods may be more accommodating to development than others, impacting the success of the investment. Development and redevelopment of real estate traditionally have more risk than other types of real estate strategies. The availability and cost of construction and development financing is uncertain and represents a risk inherent in the execution of a QOF strategy. The rules and regulations of the QOZ Program are complex, compliance with the QOZ Program comes with significant challenges. QOFs tend to be illiquid investments for ten or more years.
Any discussion regarding “Qualified Opportunity Zones” — including the viability of recycling proceeds from a sale or buyout — is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidance’s, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist, and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any.
Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter. Please contact us if you wish to have formal written advice on this matter.
Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services through Concorde Asset Management, LLC (CAM), an SEC-registered investment adviser. Insurance offered through Concorde Insurance Agency, Inc. (CIA). Fortitude Investment Group is independent of CIS, CAM, and CIA.