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Qualified Opportunity Zone Investment Tax Benefits

Designation Of Opportunity Zones Failed To Target Neediest Places

Opportunity Zones

Since policymakers enacted the 2017 tax law, governors have designated about 8,700 opportunity zones in states and territories, including Puerto Rico. Governors, who have now completed the selection process, had to choose most of these zones from localities that qualify as low-income communities, meaning that they have either a poverty rate of at least 20 percent or a median income thats no greater than 80 percent of the median income in their metropolitan area.

This definition of low-income community is broad enough to include some areas that are not truly distressed, such as areas adjacent to some elite colleges for example, the University of Virginia and the University of California at Berkeley, where a large concentration of students skews the income data. Furthermore, the law lets governors designate a subset of areas that are adjacent to a low-income community and have a median income of no more than 125 percent of the median income of the adjacent low-income community. Thus, they could designate as opportunity zones a number of areas that many would not consider distressed including Long Island City, where Amazon is moving one of its new headquarters.

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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Qualified Opportunity Zone Property

QOZ property is a QOF’s qualifying ownership interest in a corporation or partnership that operates a QOZ business in a QOZ or certain tangible property of the QOF that is used in a business in the QOZ. To be a qualifying ownership interest in a corporation or partnership,

  • the interest must be acquired after December 31, 2017, solely in exchange for cash
  • the corporation or partnership must be a QOZ business and
  • for 90% of the holding period of that interest, the corporation or partnership was a QOZ business.
  • See Form 8996 instructions.

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    Who Can Invest In An Opportunity Fund And What Benefits Do They Offer

    You can locate many of the places classified as opportunity zones on an interactive map on the U.S. Department of Housing and Urban Development’s website. Just over 23% of opportunity zones are in rural areas. Some of the opportunity zone areas may be economically blighted, while others may just be lacking in goods and services due to their rural nature. Still others may be experiencing a high level of market transition and gentrification and may be ripe for development.

    Qualified opportunity funds are key to understanding who can invest in opportunity zones. A qualified opportunity fund is an investment entity, such as a corporation or a partnership, created for investing in opportunity zone investments. Many taxpayers are eligible to invest in opportunity zones, however only accredited investors can invest in most qualified opportunity funds.

    Most QOFs are securities investments registered with the Securities and Exchange Commission and offered generally through investment advisers or broker-dealers. To qualify as accredited investors, a married couple must have earned at least $300,000 in the past two years and have a reasonable expectation for that income to continue, or have at least $1 million in net worth apart from one’s primary residence. Additional details can be found on the SEC website.

    The New Research Fills An Important Data Gap In Understanding Opportunity Zones Impacts

    Opportunity Zone Investing

    Despite their cost and scope, opportunity zones lack even the most minimal reporting requirements. To shed light on their impact, the new research from Kennedy and Wheeler, based on preliminary tax return data for 2019 and 2020, uses multiple data sources to provide important insights into programs initial impact. The reports four key findings show that:

  • Opportunity zone investment is extraordinarily concentrated in a relatively few zones, with nearly two-thirds63 percentof opportunity zone census tracts covered by the initial data receiving zero capital. Just 1 percent of tracts received 42 percent of the invested capital, and the top 5 percent received 78 percent of total investment. The New York City area received the largest volume of opportunity zone investment, at $3.8 billionmore than twice the amount received by the Los Angeles area, which ranked second at $1.7 billion.
  • Opportunity zone investment is overwhelmingly concentrated in real estate, construction, and finance. Real estate alone received more than half of opportunity zone dollars. By contrast, only 1 percent of the firms that received opportunity zone funds were in manufacturing. Rather than directly investing in property or business assets, the vast major of opportunity zone investments were structured as partnerships to allow investors to claim the special deduction for pass-through entities that was also created by the 2017 TCJA.
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    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!

    Option : Invest In A Qof Before December 31 2021

    Although this option will provide you with the most benefits, it may be difficult to pull off.

    When you realize a capital gain , they are typically given 180 days to reinvest those gains into a QOF. However, to receive the 10% step-up in basis incentive, you must invest in a QOF by December 31, 2021, even if their 180-day investment period extends into 2022.

    Finding a well-run QOF in such a short time can be tricky, and rushing such an investment is not ideal. If you want to receive the 10% step-up in basis, you must hold the QOF investment for at least five years, and to exclude the growth within the fund from taxation, you must hold it for at least 10 years. Such long-term investments should be carefully considered. You want to select a QOF that will not only provide a decent return, but also one that will follow all the IRSs requirements. If you cannot find a trustworthy QOF by the end of the year, you may be better off foregoing the 10% step-up in basis in favor of finding a better managed fund.

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    The Tax Benefits Of Opportunity Zones

    KEY TAKEAWAYS

    • Opportunity zones are a new tax benefit, established by the Tax Cuts and Jobs Act of 2017, designed to spur investment in economically distressed communities.
    • The tax benefits are two-fold: taxes owed on capital gains can be deferred, and in some cases reduced, if the gains are reinvested in an opportunity zone fund and the gains on opportunity zone investments held at least 10 years are tax free.
    • Investments in an opportunity zone are subject to many rules and restrictions, most of which are in two sets of proposed Treasury Department regulations.

    Opportunity zones are a tax benefit created by the Tax Cuts and Jobs Act of 2017 to spur investment in economically distressed communities. In exchange for qualified investments in specific places, a taxpayer may defer and reduce taxes owed on capital gains and earn tax-free capital gains for opportunity zone investments held at least 10 years.

    Facts About Opportunity Zones

    Opportunity Zones: Will Tax Breaks for Investors Benefit Communities Too?

    The Tax Cuts and Jobs Act included changes for businesses and individuals. One of these is the creation of the Opportunity Zones tax incentive, an economic development tool that allows people to invest in distressed areas. This incentive’s purpose is to spur economic development and job creation in distressed communities by providing tax benefits to investors. Low income communities and certain contiguous communities qualify as Opportunity Zones if a state, the District of Columbia or a U.S. territory nominated them for that designation and the U.S. Treasury certified that nomination. Following the nomination process, 8,764 communities in all 50 states, the District of Columbia and five U.S. territories were certified as Qualified Opportunity Zones . Congress later designated each low-income community in Puerto Rico as a QOZ effective Dec. 22, 2017. The list of each QOZ can be found in IRS Notices 2018-48 and 2019-42. There’s also a visual map of the census tracts designated as QOZs.

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    Criticism Of Opportunity Zones

    Opportunity zones and the tax benefits associated with qualified opportunity funds have received their fair share of criticism since being introduced in 2017. Some critics suggest that opportunity zones and associated investments are more about tax planning for the rich than making a meaningful long-term impact in economically disadvantaged regions across the country. According to the U.S. Environmental Protection Agency , data about opportunity zones are clear that most of the census tracts suffer from a lack of ongoing public and private investment. As a result, opportunity zones may lack key infrastructure or other assets that investors seek to ensure productive returns on their investments. The differences between various opportunity zones could mean that only a small portion of opportunity zones will be the beneficiaries of investment and long-term change.

    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 Do Opportunity Zones Work Who Can Claim The Incentives And What Projects Can They Support

    The Tax Cuts and Jobs Act included a new federal incentiveOpportunity Zonesmeant to spur investment in undercapitalized communities. Any corporation or individual with capital gains can qualify. The program provides three tax benefits for investing unrealized capital gains in Opportunity Zones:

    • Temporary deferral of taxes on previously earned capital gains. Investors can place existing assets with accumulated capital gains into Opportunity Funds. Those existing capital gains are not taxed until the end of 2026 or when the asset is disposed of.
    • Basis step-up of previously earned capital gains invested. For capital gains placed in Opportunity Funds for at least 5 years, investors basis on the original investment increases by 10 percent. If invested for at least 7 years, investors basis on the original investment increases by 15 percent.
    • Permanent exclusion of taxable income on new gains. For investments held for at least 10 years, investors pay no taxes on any capital gains produced through their investment in Opportunity Funds .

    Investors can take advantage of one or more of the benefits.

    Apart from a few sin businesses, Opportunity Funds can finance a broad variety of activities and projects. Funds can finance commercial and industrial real estate, housing, infrastructure, and existing or start-up businesses. For real estate projects to qualify for Opportunity Fund financing, the investment must result in the properties being substantially improved.

    Where Are Opportunity Zones Located And How Are They Created

    What is an Opportunity Zone? Tax Benefits &  More Explained [Free Guide]

    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.

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    How Long Should You Hold Your Investment In A Qualified Opportunity Zone

    Investors who want to defer taxes on capital gains can receive tax benefits from opportunity zones if they meet specific time requirements for investing the realized gain in a qualified opportunity fund . As a result, investors can postpone paying taxes on realized capital gains until December 31, 2026 .

    For the gains to be 100% tax-free, the investment in a QOF needs to be held for 10 years. The combination of tax deferral and tax-free investing can provide a significant advantage to QOF investments versus other traditional investments that are taxed on investment gains. A good adviser should be able to provide a side-by-side comparison for an investor of paying taxes on capital gains today versus deferring them and investing in a QOF with tax-free growth.

    Scale Your Portfolio Growth

    Investors are advised to conduct extensive research and analysis before investing in a qualified opportunity zone. To screen opportunities with ease, teams that review a high volume of deals will benefit from a deal management solution that centralizes this deal information and data in one command center. Beyond reviewing high-level metrics, thorough due diligence is critical to uncovering red flags and ensuring alignment with your goals. Download our white paper to learn how you can scale portfolio growth with purpose-built deal management software, relying on one command center to systematize your process.

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    Qualified Opportunity Zones: A Significant Tax Benefit For Investors

    The Tax Cuts and Jobs Act, passed in December 2017, contained new Internal Revenue Code Sections 1400Z-1 and 2 aimed at developing economic growth and business in certain designated, distressed, low-income communities around the country known as Qualified Opportunity Zones. The provision provides federal tax benefits to those investors who invest in funds and businesses that target the designated Qualified Opportunity Zone boundaries.

    Designated Qualified Opportunity Zones

    Qualified Opportunity Zone Fund Investments | Varnum LLP

    Q6. Do I need to live in a QOZ to take advantage of these tax incentives?

    A6. No. You can take advantage of these tax incentives even if you dont live, work, or have an existing business in a QOZ. All you need to do is invest the amount of a recognized eligible gain in a QOF and elect to defer the tax on that gain.

    Q9. How can I find the census tract number for a specific address?

    A9. You can find 11-digit census tract numbers, also known as GEOIDs, using the U.S. Census Bureaus Geocoder. After entering the street address, select Public_AR_Current in the Benchmark dropdown menu and Census2010_Current in the Vintage dropdown menu, and click Find. In the Census Tracts section, youll find the number after GEOID.

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    Tax Benefit #: Temporary Capital Gains Tax Deferral

    The first tax benefit that investors can enjoy is a temporary deferral of inclusion in taxable income. This deferral is only applicable for capital gains that are reinvested in an Opportunity Fund. Additionally, the deferred gain must be recognized before the opportunity zone investment expires or before December 31, 2026.

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    The 2 Hidden Benefits Of Opportunity Zone Investing

    Opportunity Zone investing offers two little-known hidden benefits that almost no one talks about. First, lets review the three main tax benefits:

  • When you roll over capital gains into a Qualified Opportunity Fund within 180 days, you are able to defer recognition of that gain until December 31, 2026.
  • When the tax bill on your initial gain comes due, you are able to reduce the amount of gain recognized by 10%, so long as your Qualified Opportunity Fund holding period reaches at least five years by the end of 2026.
  • You can exclude 100% of the new capital gain that accrues within your Opportunity Zone investment, after a 10-year holding period. Essentially, you pay zero tax on your long-term Qualified Opportunity Fund gains.
  • These three main tax benefits are well known. But now lets discuss Opportunity Zone investings two hidden benefits.

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    How Investing In Opportunity Zones Works

    The designation of Opportunity Zones is designed to help spur development of identified communities. In exchange for investing in Opportunity Zones, investors can access capital gains tax incentives available exclusively through the Opportunity Zone program. To access these tax benefits, investors must invest in Opportunity Zones specifically through Opportunity Funds. A qualified Opportunity Fund is a US partnership or corporation that intends to invest at least 90% of its holdings in one or more qualified Opportunity Zones. As previously mentioned, Opportunity Funds are governed by IRC section 1400Z-2 and Opportunity Funds can self-certify to the IRS. But each Opportunity Fund is responsible for ensuring that they abide by the guidelines of the Opportunity Program in order to be able to offer tax incentives.

    Because the Opportunity Zone program is intended to stimulate positive growth within designated communities, there are restrictions on the types of investments in which an Opportunity Fund can invest. These investments are called Qualified Opportunity Zone property, which is defined as any one of the following:

    • Partnership interests in businesses that operate in a qualified Opportunity Zone.
    • Stock ownership in businesses that conduct most or all of their operations within a qualified Opportunity Zone.
    • Property such as real estate located within a qualified Opportunity Zone.

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