The 2017 Tax Cut and Jobs Act created opportunity zones to spur economic development in distressed areas in towns and neighborhoods across the U.S.
Opportunity zone investments provide tax cuts for the investor, with the expectation that opportunity zone projects will also bring jobs and beneficial improvements into the targeted areas.
As of December 2018, there were 8,769 areas across the country designated as opportunity zones, identified from individual state census as low-income communities. These opportunity zone communities will hold this designation for ten years, through 2028.
Opportunity zone investing--is it right for you?
Investing in rental property is, first and foremost, a numbers game. Yes, it's great to support rehabilitation in local communities and provide safe, functional housing. But there will always be locations where the amount of money needed to bring a property up to a rentable condition outweighs the long-term benefit of owning that property.
A rental rate evaluator can assist with your property analysis to help you determine if your rental income will ensure a good return on the investment needed to improve the property.
There are a few differences between purchasing a rental property and purchasing properties within an opportunity zone. On top of the purchase, you have rules on improvement and a timeline to finish those improvements.
Properties within opportunity zones have a few rules:
• The property needs to be new construction or a building where renovation costs exceed the cost to purchase it.
• The new building OR the renovation must be complete within 30 months of purchase.
For example, if you purchase a rental property for $250,000.00, you must spend at least an additional $250,000.01 in "betterment expenses" to renovate the property.
If you are required to have such a high investment in the property between purchase and renovations, why would you want to invest in an opportunity zone?
What are the benefits of purchasing in opportunity zones?
Purchasing property within an opportunity zone brings attractive and unique benefits to an investor. stessa.com lines out four opportunity zone advantages for real estate investors compared to privately investing in distressed neighborhoods.
• The investor needs only to reinvest capital gains from a previous asset sale, not the entire proceeds.
• The investor can defer capital gains from asset sales made inside or outside of a qualified opportunity zone.
• Any type of capital gain – stocks, Bitcoin, precious metals, and more – qualifies for opportunity zone investment.
• Syndicators can create opportunity funds to invest in a variety of qualified opportunity zone opportunities, including residential rental properties.
The bottom line? Regardless of where capital gains came from (sale of a business, stocks, real estate, art, vehicles, or any other asset) -- an investor can defer paying capital gains if they invest in a qualified opportunity fund. Opportunity zone investments offer legal tax deferment and avoidance.
What types of property are available in opportunity zones?
Opportunity zones include residential and commercial housing, as well as many other types of property and business. According to fool.com, opportunity zones encompass 1.6 million businesses and over 24 million jobs.
There are many rental properties you can add to your portfolio, no matter which rentals you like to buy.
How do you identify opportunity zones?
To see a complete listing of opportunity zones across the country, visit the U.S. Department of Treasury's CDFI Fund page. When you set out to determine cash flow and rate of return for a potential investment property, the process is a little more complicated. The purchase falls under different regulations than the purchase of a typical rental property because you must invest through a qualified opportunity fund.
What is a qualified opportunity fund?
The IRS defines qualified opportunity funds as U.S. partnerships or corporations set up to invest at least 90% of its pooled capital in an eligible property located in a qualified opportunity zone.
Why would you want to invest in an opportunity fund?
Real estate investments offered through opportunity funds can provide capital gains deferrals not available in most other real estate investments.
These tax breaks add up over time:
• At five years of ownership, 10% of the original capital gains are excluded from taxation.
• Keep the asset for at least seven years, and 15% of initial capital gains are excluded from taxation.
• If you hold the asset for at least ten years, you become eligible for the most substantial tax break: permanent exclusion of opportunity zone gains from your taxable income.
As a rental property owner, you remain eligible for the regular tax deductions through your business of leasing and maintaining a rental property.
Here's an example of how the capital gain deferment works:
You sell an apartment building you currently own and make a capital gain of $500,000 on the sale.
• Invest that $500,000 in an opportunity fund, and after five years, your taxable capital gain would be reduced by 10%, to $450,000.
• After seven years, your taxable gain would be reduced by an additional 5%, to $425,000.
• Your reduced and deferred capital gains tax on the $500,000 gain would be due after nine years.
• Any appreciation for your initial $500,000 investment in the opportunity fund would be completely tax-free after ten years.
You can defer taxes until the sale date of the opportunity zone investment or until December 31, 2026.
How do you invest in a qualified opportunity fund?
A well-qualified opportunity fund provider will have a track record of investing successfully in opportunity zones. Network with real estate developers, economic development agencies, and commercial real estate brokers to find a good QOF.
Opportunity zones offer real estate investors a viable path to defer taxes on existing capital gains and permanently eliminate new capital gains – while supporting improvements and growth in distressed communities across the United States.
For the full details on how opportunity zones and funds work, visit the IRS FAQ page.
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