At this point, most of us have heard of the Tax Cuts and Jobs Act (TCJA). Passed in 2017 and touted as the most significant tax reform legislation in over three decades, this transformative bill did more than revamp the terrain for individual taxpayers; it also paved the way for an unprecedented investment model touting potentially significant tax incentives on capital gains: The Opportunity Zones program.
Opportunity Zones Program: Understanding The Basics
The Opportunity Zones program was designed to motivate private investors to stimulate job creation and financial growth within designated “economically distressed” neighborhoods and districts. Previously, the U.S. government relied on individual taxpayer dollars to revitalize struggling communities. However, under the new Opportunity Zones program, the government now offers extensive (and exclusive) capital gains tax incentives to private investors that meet program qualifications.
The program initially launched on April 9, 2018, with 18 states officially appointing their local Opportunity Zones. The rest of the country followed suit throughout the year, with governors assigning Opportunity Zone status to all 50 U.S. states and the District of Columbia (appointed by its mayor). Additionally, five U.S. possessions have Opportunity Zone designations, including the Virgin Islands, Guam, Northern Mariana Islands, American Samoa, and Puerto (almost all of which is classified as an Opportunity Zone). In total, more than 8,700 census tracts have received Opportunity Zone Status.
Investors Must Set Up A Qualified Opportunity Fund (QOF) To Secure Program Eligibility
To tap into the perceived benefits of the programs, investments must be made into a Qualified Opportunity Fund (QOF). A QOF is a newly defined investment vehicle organized as a partnership or corporation for the sole purpose of Opportunity Zones Investment. To benefit from the tax incentives and remain compliant with program laws, the Opportunity Fund must hold at least 90% of its assets in an appointed Opportunity Zones property.
Three Reasons To Consider Participating In The Opportunity Zones Program
Despite its recent launch and many moving parts, private investors and commercial real estate professionals across the country are already showing interest in stimulating growth and development in low-income communities, while leveraging three significant tax benefits:
Temporary Deferral Of Taxable Income
The IRS allows for a temporary delay of inclusion of taxable income for any capital gains that are reinvested into a Qualifying Opportunity Fund within 180 days. The temporary deferral protects the capital gains from being taxed until December 31, 2026, or when the investment is sold, whichever comes first.
Basis Increase For Capital Gains
Additionally, the Opportunity Zones Program also offers a basis increase for any capital gains reinvested in a Qualifying Opportunity Fund. The step-up in basis is 10% for an Opportunity Fund held by the taxpayer for at least five years. The basis increases an additional 5% if the Opportunity Fund is maintained for at least seven years, resulting in a total possible exclusion of up to 15% of the original gain from being taxed.
Permanent Deferral Of Taxable Income
Finally, the IRS allows for a permanent tax exclusion on capital gains accrued from the sale or exchange of an Opportunity Fund investment as long as the investment is held for a period lasting at least ten years. The permanent exclusion only applies to gains amassed following an investment in a QOF.
Real Estate Investors Are Proceeding…But With Caution
Will these new tax incentives impact the commercial real estate vertical? It’s still too soon to tell. Intrigued by the possibility of a minimized overall tax burden, the Opportunity Zones Program has captured the attention of investors and real estate developers across the country. Yes, there’s a lot of industry buzz surrounding the opportunity for driving profits using this program. However, there are still a lot of questions. As a newly launched initiative, it’s still too soon to tell if there is, in fact, any fine print investors need to know and understand before moving forward. The US Treasury released the first set of proposed opportunity zone guidance in October. As a result, many real estate professionals are opting for a “proceed with caution” approach with the Opportunity Zones Program, choosing to soft-circle funds and financing, so it’s ready and waiting as needed, without a legally binding commitment.
Still have questions about whether the Opportunity Zone Programs makes sense for your commercial real estate investment needs? We can help. Contact Southpace Properties today to consult with a licensed and experienced real estate professional.
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