The new tax incentives for Opportunity Zones have made a big splash. The smart money predicts cash inflows of at least $100 Billon in 2019. If you are a developer or investor, you’ll want to evaluate your property purchases carefully to see if they are eligible to benefit from the new government incentives.
What Exactly Are Opportunity Zones?
An Opportunity Zone is an economically-depressed community that provides preferential tax treatment under certain conditions. To receive the Opportunity Zone designation, the state must nominate the community and the U.S. Treasury Secretary must approve it. These nifty tax breaks were added to the 2017 Tax Cuts and Jobs Act, but it took a while for them to catch on. All 50 states, Washington DC and the five U.S. territories each have at least one Opportunity Zone.
What Are Qualified Opportunity Funds?
QOFs are investment vehicles, either corporations or partnerships, that facilitate an investor’s investment in eligible properties within a Qualified Opportunity Zone. There are two major tax benefits related to investing in one of these zones:
- Tax Deferral: You can defer taxes on any prior gains invested in a QOF until the earlier of the investment’s exchange/sale and the last day of 2026. If you hold the QOF investment for more than five years, you get a 10% exclusion on the deferred gain, or 15% if your holding period is seven or more years.
- Basis Step Up: If you hold your investment in a QOF for at least 10 years, you can step up your investment cost basis to the property’s fair market value as of the date of the investment’s sale or exchange.
You can get the tax benefits of a QOF without living or working in the zone. QOFs are designated by census tract numbers, or GEOIDs. You can form your own QOF for specific Opportunity Zones by filing IRS Form 8996, Qualified Opportunity Fund, with its federal tax return. You then can defer a capital gain on your current income tax filing using Form 8949.
You will want to hold your Opportunity Zone investment for at least 10 years, so you’ll need a well-conceived hold/disposition strategy for each deal. It makes sense to figure your cash-on-cash return rather than your internal rate of return, since the latter is sensitive to the time value of money. A 12% to 14% cash flow should be sufficient to generate income over the entire 10-year holding period. You must use invested capital gains to substantially improve the property or business in the Opportunity Zone. You can do this several ways, but the most straightforward is to start with raw land. Returns decrease as time goes by, from 3.08% in 2018 to 1.74% in 2025, so don’t wait – jump in now! Speak to us at SLG for financing options to help you take advantage of this opportunity.