Who doesn’t love the idea of helping struggling communities while generating impressive returns?
That’s the idea behind the Opportunity Zone program, which came to life as part of the Tax Cuts and Jobs Act of 2017. The program uses tax breaks to incentivize investors to invest in low-income communities, and it could draw trillions of new dollars into the CRE sector.
Brokers who understand the program will be ideally positioned to ride that wave of capital, especially considering how many questions there are about the finer points of Opportunity Zone regulations. Those questions are currently holding most investors back, and while funds like Virtua Partners and Fundrise are moving forward, most people are waiting for the final rules from Washington before pulling the trigger.
The Trump administration released a 74-page document in October offering guidance and proposed regulations on the program, yet the final guidelines are still uncertain. But that doesn’t mean there are no details about how to take advantage of Opportunity Zones, and brokers should be the first ones to understand this program. The tax benefits promise to attract hordes of new investors, and those investors will want to work with brokers who best understand the regulations and market opportunities.
So from knowing what qualifies as an Opportunity Fund to making the most of the program’s tax breaks, here’s what brokers need to know to capitalize on this unique opportunity.
What qualifies as an opportunity fund?If you want to reap the advantages of the Opportunity Zone program, you need to invest in an Opportunity Fund. Fortunately, starting an Opportunity Fund is incredibly simple.
The October document released by the Trump administration explains, “The proposed regulations generally permit any taxpayer that is a corporation or partnership for tax purposes to self-certify as a Qualified Opportunity Fund, provided that the entity self-certifying is statutorily eligible to do so.”
Additionally, for a corporation, LLC or partnership to qualify as an Opportunity Fund, the fund needs to hold 90% of its total assets within Qualified Opportunity Zones. It’s likely most Opportunity Funds will be attached to private equity firms or banks, but there’s nothing stopping a two-person partnership from opening their own Opportunity Fund. To do so, all you have to do is self-certify and attach Form 8996 to your federal tax return.
How the tax benefits workMore than 8,700 neighborhoods across the country are certified Opportunity Zones, and investing in any of these areas could result in serious tax benefits. Those benefits break down into three categories:
Temporary tax deferral for capital gains invested in an Opportunity Fund until 2026
Up to a 15% tax cut on those gains when they do get taxed in 2026
No taxes on the fund’s appreciation if it’s held for at least 10 years
Importantly, any reinvested capital gains must be invested in an Opportunity Fund within 180 days of their realized exchange date to qualify.
These are groundbreaking benefits, and while they bear a resemblance to some of the tax draws of 1031 exchanges, a major difference is you do not have to reinvest proceeds from “like-kind” assets into an Opportunity Fund. That means capital gains from a variety of investments, whether it’s stocks, businesses or even art, can be reinvested into Opportunity Zones to receive tax benefits.
This flexibility promises to entice investors from across the marketplace into the CRE sector, and some industry estimates put the total value of unrealized U.S. gains in the trillions.
Understanding the substantial improvement testTo help ensure Opportunity Zone investments actually benefit the community and aren't simply used to dodge taxes, every investment in the program is subject to a “substantial improvement” test.
This test dictates that the costs invested in improving a property are greater than the original cost of the investment, meaning investors have to make serious improvements to Opportunity Zone properties to qualify for the tax breaks. Fitting with the program’s goal of helping low-income communities, the rule benefits investors who make serious, long-term investments in Opportunity Zone properties rather than those who just want to reduce their taxes.
Don’t let the uncertainty stop youThere is enough information about Opportunity Zones to start getting ahead of the trend today, but investors still have many questions.
When will the final rules be released? How exactly will the substantial improvement test be measured? The IRS released an unofficial list of Qualified Opportunity Zones, but when will the official list be released?
President Trump signed an executive order to allocate more federal resources into the Opportunity Zone program earlier this month, and the Trump administration is accepting public comments about the program ahead of a public hearing scheduled for January 10, 2019. While it’s hard to say exactly when we’ll get the final rules, it looks like early next year is a safe bet.
But don't wait until then to take advantage of the Opportunity Zone program. Opportunity Zones are exciting investors across the marketplace, and the program could easily pump trillions of new dollars into the CRE sector. Brokers who position themselves ahead of this trend will be the best positioned when the rules eventually hit the books, so start thinking about your local Opportunity Zones today and get a step ahead of the competition.