How to Invest in Opportunity Zones

Introduction

Opportunity Zones are an attractive investment opportunity where investors can benefit from unique tax advantages. These areas are defined as economically distressed American communities where investments can qualify for favorable tax treatment. The federal government established qualified opportunity zones as part of the Tax Cuts and Jobs Act of 2017 to encourage investment in these areas and promote economic development.

How to Invest in Opportunity Zones in Two Ways

The primary way individual investors can invest in opportunity zones is through Opportunity Zone Funds. According to the Internal Revenue Service (IRS), this type of fund, known as qualified opportunity funds, is “an investment vehicle organized as a Corporation or Partnership for the purpose of investing in Qualified Opportunity Zone property.”

These Opportunity Zone Funds are primarily managed by large investment funds that invite wealthy individual investors to join. The investment fund selects investments that it believes will provide the greatest return for investors. These investments can include physical assets and equity stakes in local businesses.

While investments in these funds are not necessarily limited to certain types of individuals, they often require a minimum investment ranging from tens (or even hundreds) of thousands of dollars. However, the federal Opportunity Zones law does not require a minimum or maximum investment.

There are approximately 300 Opportunity Zone funds across the country.

The other way to invest in Opportunity Zones is through a Real Estate Investment Trust (REIT) for Opportunity Zones. A REIT is a company that owns and manages real estate investments. Individuals can indirectly invest in real estate by purchasing shares in a REIT. This type of investment requires less initial capital than direct investment in an Opportunity Zone Fund.

What You Should Know Before Investing in Opportunity Zones

The reason that Opportunity Zone Funds are an attractive investment for those who can afford it is the tax benefits they provide. By investing in an opportunity zone through such a fund, investors can temporarily defer paying capital gains taxes. Once the asset is sold for a profit, they have 180 days to reinvest the funds in a qualified opportunity fund. If they do so, they can defer paying capital gains taxes until 2021 or later.

In addition to deferring taxes, investing in an opportunity zone allows investors to reduce future capital gains taxes by increasing their tax basis.

Capital gains taxes apply to the difference between the amount an investor sells the asset for and its basis – which is typically the amount they initially paid. Investors can increase their basis, thereby reducing their capital gains tax burden by 10% or 15%, by holding their investment in a qualified opportunity fund for five or seven years.

The higher basis is available only to investors who have held their investment for five or seven years before December 31, 2026. Therefore, to take advantage of the 15% basis increase for seven years, an investor must have invested in a qualified opportunity fund by December 31, 2019. Investors also have until December 31, 2021, to invest in qualified gains to benefit from the 10% basis increase for five years that lasts until the end of 2026.

Finally, if investors hold their investment in an Opportunity Zone Fund for at least 10 years, they can avoid paying capital gains taxes altogether.

Federal regulations stipulate that recognized gains can be invested before December 31, 2026, in opportunity zones and benefit from the permanent 10-year exclusion. Due to the rule that gives investors 180 days to invest their gains, the deadline to invest in Opportunity Zone Funds is June 30, 2027.

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In exchange for the tax benefits they receive, Opportunity Zone funds must meet certain requirements. At least 90% of the fund’s investments must be in tangible assets located in the opportunity zone or an equity stake in businesses located in the opportunity zone. Half of those businesses that have been invested in must derive their gross income from a “business activity” located in the opportunity zone.

Understanding the Risks of Investing in Opportunity Zones

Despite the tax benefits that come with Opportunity Zone investments, it is also important to discuss some risks.

The first prominent risk of Opportunity Zones is that they may not necessarily deliver the benefits for which they were designed. According to the Center on Budget and Policy Priorities, Opportunity Zones primarily benefit wealthy investors who enjoy tax breaks, and they are expected to lead to the loss
Source: https://www.thebalancemoney.com/how-to-invest-in-opportunity-zones-5207125