7 Facts to Know About Opportunity Zone Investing

Investors can receive tax perks through a new federal program.

The Tax Cuts and Jobs Act of 2017 created an opportunity for investors to minimize taxes on capital gains while improving low-income areas. Opportunity zones are aimed at creating jobs and providing incentives to develop economically distressed communities that are certified by the Internal Revenue Service. As with most government programs, there are complex rules with this type of investing. Here are a few answers to several common questions about investing in opportunity zones.

What is an opportunity zone?

An opportunity zone is a designated economically distressed area, nominated by its respective state. These zones exist in parts of all 50 states, the District of Columbia and five U.S. territories, according to the IRS. In New York City, for instance, Opportunity zones include sections of Harlem and Washington Heights. Other sites in New York include parts of Long Island City in Queens, neighborhoods in Brooklyn as well as an area near the Yankee Stadium in the Bronx, says Mihal Gartenberg, a real estate agent at Warburg Realty in New York. Experts say investments in these areas may be eligible for preferential tax treatment.

What are the benefits of investing in an opportunity zone?

Opportunity zone investing offers tax incentives, not credits. Those who invest in qualified opportunity funds, known as QOF, can defer taxes on prior capital gains, if those gains are invested in a qualifying fund within 180 days. The length of the tax deferral is until Dec. 31, 2026 or when the QOF is sold or exchanged. If the investment is owned more than five years, 10 percent of the gain is excluded from taxes. If it’s held longer than seven years, the exclusion amount jumps to 15 percent. The greatest benefit goes to investors who hold their QOF investment for at least 10 years. At that point, an investor’s capital gains can be eliminated.

Who can invest in an opportunity zone?

Investors with large capital-gains bills are appropriate candidates for these funds. But Aaron Clarke, a wealth advisor at Halpern Financial in Ashburn, Virginia, says it’s a limited market. “They are really only appropriate for serial entrepreneurs — people who are real estate investors by trade (not a hobby) and people who have a strong local knowledge of the opportunity zone they plan to invest in,” he says. Currently, most qualified opportunity zone investments are available to accredited investors. Investors typically need to be high-income earners, such as those with annual incomes of at least $200,000 who file with a single status, or have a net worth above $1 million, excluding their primary residence.

How do I invest in opportunity zones?

The easiest way to invest in economic opportunity zones is through a fund. “The QOF must invest in a qualified business or property that meets the eligibility criteria, including commercial real estate or agricultural projects within the opportunity zone,” says Austin Maness, chief operating officer at Harvest Returns in Fort Worth, Texas. Not surprisingly, the number of opportunity zone funds are growing rapidly. From crowdfunding platforms, such as Fundrise, to the Pearl Fund, there are many new offerings in the QOZ sphere. Clarke doesn’t recommend single project opportunity zone investments due to the concentrated risk. He says diversified funds can reduce the peril of exposure to one property, albeit with potentially high fees.

What qualifies as an opportunity zone investment?

Opportunity zone funds must be certified by the U.S. Treasury Department and hold at least 90 percent of its assets in a QOZ property. To invest in the distressed properties in urban and rural areas, a fund must be organized as a corporation or partnership. Opportunity funds are limited to equity investments in businesses, real estate and assets that are located in a qualified opportunity zone. Loans are excluded from the tax incentives. The real estate in the fund must also need extensive rehabilitation.

Are there investment risks with these funds?

Proceed with caution when investing in an opportunity zone fund, experts say. “The risk that a bad investment is cloaked inside an opportunity zone investment is something investors must be wary of, as tax savings can be a very sexy sale,” says Stephen J. Taddie, a managing partner at Stellar Capital Management in Phoenix. The investments within an opportunity zone must stand on its own. There’s a risk that the land and buildings within a zone may already have appreciated, leaving less profit for incoming investors, he adds. While opportunity zone funds are diversified, Clark warns that “they are laden with high costs that may offset the tax benefits.”

Can a misstep reduce the tax benefits?

The U.S. Treasury is still clarifying guidance on various investment scenarios related to opportunity zone investing, says Jim Achen Jr., senior vice president at Transwestern, a Phoenix-based commercial real estate company. He adds that the provisions of these investments are complex, and a misstep can minimize the tax benefits. Clayton Wyatt, vice president of business development at Roofstock, an online real estate investing company, says investors should be wary of “cowboy funds” that overpromise and put capital at risk. With a new investment it’s crucial to invest with a known sponsor, as there isn’t a track record for the performance of previous funds. That said, investors with high capital gains may profit from these investments.

Opportunity zones provide investors with tax incentives.

Here are few common questions investors should weigh when considering whether to invest in an opportunity zone:

— What is an opportunity zone?

— What are the benefits of investing in an opportunity zone?

— Who can invest in an opportunity zone?

— How do I invest in opportunity zones?

— What qualifies as an opportunity zone investment?

— Are there investment risks with these funds?

— Can a misstep reduce the tax benefits?

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7 Facts to Know About Opportunity Zone Investing originally appeared on usnews.com

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