Consider Focusing On Puerto Rico
Puerto Ricowhich is rebuilding its energy infrastructure in the wake of the devastation of Hurricane Mariareceived special treatment, with 835 of 945 low-income tracts qualifying as opportunity zones.
Of particular interest should be Puerto Rico, which after Hurricane Maria has made a concerted effort to promote alternative energy, especially solar energy, said Petra.
Last year, the U.S. Department of Treasury certified over 8,700 individual census tracts as Qualified Opportunity Zones in 50 states, six territories and the District of Columbia, he said. About 35 million people live in these zones, which are established for 10 years.
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Opportunity Zone Investments In Real Estate
Real estate-related Opportunity Funds have the most traction, understandably.
For investors and real estate developers, Opportunity Zones offer cheap real estate and an unlimited, untaxed upside if a neighborhood takes off.
You can invest in any type of real estate a single-family home, an apartment complex, a shopping center, or even a skyscraper office building.
Keep in mind that if you decide to go the real-estate route, you must do more than just throw cash at a piece of land or crumbling property. The government wants investors to make swift and significant improvements to an existing property to expedite the neighborhoods revitalization.
To qualify for tax perks under the program, you will need to invest the same amount into the property as your initial cost . And you will need to do so within 30 months of the purchase.
This is called the Substantial Improvement Test.
For one thing, it applies when you buy a pre-existing property or an already existing business.
For your real estate investment to qualify for the programs tax benefits, you cant just buy it and sit on it for ten years. You need to improve it.
The current Opportunity Zone legislation states that within 30 months of purchasing any built property, you need to substantially improve it using funds at least equal to 100% of the original investment.
Fortunately, you dont need to improve any land associated with the property, only physical buildings.
How Do Opportunity Zones Work
Individuals and businesses that invest capital gains from the sale of another investment into projects in Qualified Opportunity Zones receive specific tax benefits. Opportunity Zones are designed to fuel economic growth and job creation through projects like affordable housing, student housing, workforce housing, renewable energy investments, multifamily residential, and small-business development in these designated distressed areas.
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Where Are Opportunity Zones Located And How Are They Created
Opportunity zones are dispersed throughout the country and represent 11% of all U.S. census tracts. Spread throughout a mix of urban, industrial, suburban and rural areas, opportunities zones are home to over 30 million people. You can view an interactive map of qualifying opportunity zones on the U.S Department of Housing and Urban Development website.
Individual states, in collaboration with local governments, were able to nominate a specific geographic area for the Qualified Opportunity Zone program through March 21, 2018. These areas were required to meet certain low-income requirements, among other criteria. The actual certification as an opportunity zone comes from the IRS.
New Market Tax Credits Explained
The New Market Tax Credits program was enacted in 2000 as part of the Community Renewal Tax Relief Act. The goal was to spur private investment in impoverished communities. Investors place investment capital in Community Development Entities — financial intermediaries certified by the U.S. Treasury — for equity in real estate, community centers, or businesses in financially distressed communities in exchange for a credit on their annual tax return totaling 39 percent of their investment. The credit can be claimed for seven years.
At the end of the fiscal year 2020, the NMTC program had led to the creation of more than 230,000 square feet of new retail, office, and manufacturing space and financed close to 7,800 businesses in low-income communities.1
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Opportunity Zones Require Extra Scrutiny
However, when you do find a good investment with a good sponsor, you should take advantage of the offering quickly. We are seeing quality deals fill up very fast because more money is available than there are low risk, value-add deals.
Before SMARTCAP will consider an OZ investment, there are key questions and issues we think about. We ask all our investors to go through this thought process before considering any SMARTCAP offering.
Make Apples-to-Apples Comparisons: Don’t Mix After-Tax with Pre-Tax Returns
First off, consider that an OZ investment generates about a 300-basis point increase in net return to the investor, depending on the projected total Internal Rate of Return of the investment. As an example, a 12% IRR in an Opportunity Zone is equivalent to approximately a 15% IRR in a taxable account after accounting for the payment of tax.
Look at the Returns Over Ten Years
Not all IRRs are created equal. A 12% – 13% IRR is much more difficult to achieve over a 10-year hold than a 15% IRR is to achieve over a 3-year hold. This is due to the fact that the long-term IRR stabilizes around the cash flow distribution made to investors.Look at the chart below to see how this affects an investment over time.
Risk Increases if You Let Short-Term IRR Drive Decisions
How To Invest In An Opportunity Zone
Investors in a free market can allocate capital to any asset class, geographic region, or sector that they choose. With that said, factors such as tax incentives, demographics, seasonality, ethical ideology, and growth prospects often play a key role when it comes to narrowing down investment choices.
To incentivize investment in low-income communities, the federal government created qualified opportunity zones and a host of tax benefits available for those who invest in them via a qualified opportunity fund. For those unfamiliar, a qualified opportunity fund is an investment vehicle, such as a corporation or a partnership, that is organized for the purpose of investing in assets within qualified opportunity zones.
For a corporation or partnership to become a qualified opportunity fund it must self-certify by annually filing Form 8996 with its federal income tax. Once designated, qualified opportunity funds must invest at least 90% of their assets in designated opportunity zones to be eligible for tax benefits.
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The Importance Of Consulting An Attorney
As business people, we look at the definition of opportunity zones in geographic areas and the qualification requirements of the business, he said. Because its not always easy to determine whether a business qualifies for the benefits, his company always consults attorneys. Our attorneys advise us about how to present our applications for qualification, he said.
The eligible tracts for the zones are based on economic indicators of median family income and poverty, said Petra. States are limited to establishing zones in 25% of their low-income communities. In other words, if a state has less than 100 tracts identified as low-income communities, 25 qualify, he explained. The tracts are chosen based on statistics from the U.S. Census.
Opportunity Zones Explained: A Helpful Solar Incentive
Federal opportunity zones, which offer tax benefits to qualifying businesses, are little known and not always well understood. But they can offer important advantages to solar companies, adding to solar tax benefits such as the federal Investment Tax Credit .
Opportunity zones were created to promote economic development in low-income communities by allowing companies to defer capital gains taxes, said Roman Petra, attorney for Nelson Mullins who specializes in commercial real estate transactions.
The zones offer tremendous value for solar, said Jim Spano, a managing partner of Spano Partner Holdings, who has been involved in the development of more than 300 megawatts of solar. Having a tax break in areas where economics dont support solar can provide lower cost of capital and opportunities for projects to pencil out.
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How To Calculate Your Personal Tax Savings
We have created a free Excel Opportunity Zones Calculatorthat shows you the potential tax savings for your PERSONAL situation.
This excel sheet allows you to enter details about your personal situation, current gains and prospective investments to see a performance comparison.
The calculator will show you
- How much you will save on capital gains taxes on your original asset if you sell it and invest the proceeds in an Opportunity Zone
- How much less in tax you will pay if you invest in Opportunity Zones when compared to traditional investment.
- NET after-tax side-by-side comparison for investment results for Opportunity Zone vs traditional investment.
This sheet could save you hours trying to figure out if an investment in opportunity zones is right for you.
Don’t Let Just Anyone Explain Opportunity Zones To You
We have heard myths, pitches, exaggeration, and hyperbole. Sometimes all at the same time. In fact, we’ve seen very few actual investments that make real sense inside an Opportunity Zone.
It is especially critical to understand the risk profile within Opportunity Zones. As we explained in December, All Opportunity Zones are Not Created Equal. Neither are all deals created equal.
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What Defines An Opportunity Zone
There are nearly 9,000 opportunity zones in all 50 states, plus five U.S. territories, which are home to about 36 million people, or 12 percent of the population. The zones include urban, suburban, and rural areas. Basically, each zone must have a poverty rate of at least 20 percent or median family income of no more than 80 percent of the statewide income, in most cases.
Deferral Of Eligible Gain
Gains that may be deferred are called “eligible gains.” They include both capital gains and qualified 1231 gains, but only gains that would be recognized for federal income tax purposes before January 1, 2027, and that aren’t from a transaction with a related person. To obtain this deferral, the amount of the eligible gain must be timely invested in a QOF in exchange for an equity interest in the QOF . Once this is done, taxpayers may make an election to defer the gain on their federal income tax return for the taxable year in which the gain would have been recognized if they had not deferred it.
Taxpayers may make an election to defer the gain, in whole or in part. For additional information, see How To Report an Election To Defer Tax on Eligible Gain Invested in a QOF in the Form 8949 instructions.
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Tax Deferral And Savings
A Qualified Opportunity Fund investment provides potential tax savings in three ways:
Tax deferral through 2026 – A taxpayer may elect to defer the tax on some or all of a capital gain if, during the 180-day period beginning at the date of sale/exchange, they invest in a Qualified Opportunity Fund. Any taxable gain invested in a Qualified Opportunity Fund is not recognized until December 31, 2026 , or until the interest in the fund is sold or exchanged, whichever occurs first. In addition, the deferred gain can be further reduced as described below.
Step-up in tax basis of 10% or up to 15% of deferred gains – A taxpayer who defers gains through a Qualified Opportunity Fund investment receives a 10% step-up in tax basis after five years and an additional 5% step-up after seven years. Note that to take full advantage of the 15% step-up in tax basis, the taxpayer must have invested by December 31, 2019. When the tax is triggered at the end of 2026, the taxpayer will have held the investment in the fund for seven years, thereby qualifying for the 15% increase in tax basis.
No tax on appreciation – Remaining in the Qualified Opportunity Fund for at least 10 years results in the cost basis of the property being equal to the fair market value on the date of sale/exchange.
Offsetting The Step Down Of The Itc
In an ideal world, I believe the zones will be utilized and they will help offset some of the step down in the Investment Tax Credit , Spano added.
The ITC is a 30% tax credit for solar systems on residential and commercial properties, and steps down to 26% in 2020, 22% in 2021, and in 2022, 10% for commercial and utility-scale projects and zero for solar.
The final benefit of the Qualified Opportunity Zones program is if the investor holds the investment for more than 10 years, any subsequent gain recognized escapes federal tax entirely, said Petra. Overall, the tax benefits available to investors should translate to long-term, cheaper capital, he said.
To date, most of the qualifying transactions in the zones have been in real estate, said Petra. Generally, real estate projects are well suited but as folks have gotten more comfortable with the program, other industries have gained interest in the program.
Has your company been involved in solar developments in Opportunity Zones? Share your experience in the comment section below!
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Opportunity Zones Explained: Not All Are Risk
Theres a frenzy of interest around Opportunity Zones brought about by 2017 US tax law changes. Investors like you are interested in the prospect of having this very enticing investment model explained. Most people want to understand the massive tax incentive. If youre smart, youll think about Opportunity Zone risks and be prepared to resist the hype.
Finding the right Opportunity Zones, explained Tim Shoultz, President of SMARTCAP Group, is like searching in the fog for a specific tree. Its hard to discover a qualified investment and the risks are not that obvious.
Tax Advantages Of Investing In Opportunity Zones
The primary tax benefit for investors of qualified opportunity funds is that they can defer tax payments on capital gains realized from prior investments. More specifically, if an investor allocates capital gains from a prior investment into a qualified opportunity fund within 180 days from the sale date, then that person is eligible to defer tax payment on the gain until the opportunity fund is sold or Dec. 31, 2026, whichever comes first.
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How Does The Opportunity Zone Program Work
The law passed by Congress in December of 2017 states:
- Qualified Opportunity Zones must be certified by the U.S. Department of the Treasury and are required to hold at least 90 percent of their assets in qualified opportunity zone businesses and/or business property.
- To qualify, capital gains must be invested in a Qualified Opportunity Fund within 180 days of the date of the sale or exchange that generated the gain.
- The tax deferral is temporary and the program ends on December 31, 2026.
Today, the U.S. Department of the Treasury and the IRS released proposed regulations on Opportunity Zones designed to incentivize investment in American communities. The Treasury Department plans on issuing additional guidance before the end of the year after notice and comment.
Budgetary And Economic Costs Of The Opportunity Zone Program
The Joint Committee on Taxation estimates the Opportunity Zones program will cost $1.6 billion between 2018 and 2027. The program is estimated to decrease revenue between 2018 and 2025 but generate revenue in 2026 and 2027, as investors can no longer defer taxes on the capital gains they reinvested in QOFs.
Opportunity Zone Cost
Importantly, new regulations stipulate that the programs benefits would continue through at least 2048, meaning the revenue impact of the program could increase over time depending on how much activity occurs within opportunity zones.
We also know that, as with any tax provision, the economic cost of the program will exceed its budgetary cost. Navigating the programs new set of rules and regulations will generate direct compliance costs for investors, and investors will forgo investments in other areas of the economy to take advantage of the programs tax incentives.
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On Your 2026 Tax Return You Report The Capital Gains Tax On The Original Asset You Sold
And since, by now, you have held the Opportunity Zone investment for over five years, you also can claim the 10% tax reduction on the taxable amount of your original capital gain.
Example, continued: In April 2027, you pay a capital gains tax on $180,000 from the sale of the Apple stock several years ago.
Calculating The Tax Benefit Of An Opportunity Zone Investment
In the example above, investing the $500,000 capital gain from the traditional asset in a qualified opportunity zone would allow the investor to defer and reduce the $119,000 tax owed. The investor could potentially earn additional capital gains tax-free, depending on how long the opportunity zone investment is held.
Investments held at least five years receive a cost basis step-up equal to 10% of the capital gain
Investments held at least seven years receive an additional basis step-up equal to 5% of the capital gain and
Capital gains from the opportunity zone investment are tax free if the investment is held at least 10 years.
The table below illustrates the tax benefits of investing proceeds from the sale of a traditional asset in an opportunity zone.
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New Research Adds To Evidence That Opportunity Zone Tax Breaks Are Costly And Ineffective
Policymakers should enact commonsense reforms to opportunity zones to boost transparency and accountability, stem rising costs, and focus attention on communities most in need.
Important new research by economists Patrick Kennedy and Harrison Wheeler adds to a growing volume of evidence that opportunity zone tax breaks, created as part of the 2017 Tax Cuts and Jobs Act , are costly and poorly targeted and do little to create jobs or improve conditions in poor communities. Instead, opportunity zones provide massive tax benefits to wealthy investors while subsidizing investment in few communities with relatively higher incomes, home values, and educational attainment as well as stronger income and population growth.
A growing body of evidence bolsters the case for commonsense reforms that would improve the transparency and accountability of zone incentives, such as instituting reporting requirements and requiring assets used to qualify for tax breaks to be used exclusively within a zone. Absent future evidence to the contrary, opportunity zone incentives should not be extended beyond their scheduled 2026 expiration.
The 3 types of opportunity zone tax breaks