Qualified Opportunity Zones, The Major Income Tax Benefits for Real Estate Investors

Qualified Opportunity Zones, The Major Income Tax Benefits for Real Estate Investors

Attention: Investors, Developers, Family Offices, Fund Managers, Owners and Potential Owners:

The U.S. Treasury Department and the IRS through the Tax Cuts and Jobs Act of 2017 (“TCJA”) established Qualified Opportunity Zones (“QOZs”) to spur private investment in distressed, low-income communities throughout the country by offering investors preferential tax treatment. The goal is to have the benefits reach those who need it the most. This month the official list of designated QOZs was posted along with an interactive map of the census tracts now available.

QOZs will retain the designation for 10 years. Investors can defer tax on any prior gains until no later than December 31, 2026, so long as the gain is reinvested in a Qualified Opportunity Fund, (referred to herein as Opportunity Funds) an investment vehicle organized to make investments in Opportunity Zones. In addition, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor would be eligible for an increase in its basis equal to the fair market value of the investment on the date that it is sold. What does that mean?

Qualified Opportunity Fund

A Qualified Opportunity Fund is a privately managed investment vehicle, whose sole purpose is to invest at least 90% of its assets directly into QOZs. In addition, the fund must have acquired the property after December 31, 2017.

Tax Incentives

There are specifically two major potential opportunities for tax benefits:

  1. An investment into an Opportunity Fund held for at least 10 years, will eliminate the investment gain. A permanent exclusion on taxable gain.
  2. If a gain is reinvested or rolled-over into an Opportunity Fund within 180 days of the date the property was sold there will be a temporary deferral of income tax. 10% of the gain on investments in the Opportunity Fund may be excluded if the taxpayer holds the interest in the Opportunity Fund for at least five years. This exclusion may be increased by an additional 5% if the investment is held for at least seven years. A total deduction of 15% of the taxable gain.

This month the official list of designated QOZs was posted. See the list here and the thousands of census tracts now available as well as the interactive map.

Example 

An individual purchased stock in 2015 for $5M and sold it in 2018 for $8M. This would give the individual a realized gain of $3M, normally subject to capital gains tax of 714K (($3M X 23.8% = $714K) (20% tax bracket and 3.8% net investment for high earners yielding a 23.8% tax rate)).

The individual can now defer this tax by reinvesting into a qualified opportunity fund (QOF) within 180 days of the sale or disposition of a short or long-term gain.

This individual puts his earnings of $8M into a QOF.

With a QOF, now the individual can eliminate 10% or 15% of the deferred gain of $3M if they hold the qualified opportunity fund for 5 or 7 years respectively, and it gets better.

QOF’s main tax advantage is that if the investment in the fund is held for > 10 years, the individual does not have to recognize taxable gains on any appreciation when realized (sold). So assume in 2028 the fund is sold for $10M (an additional appreciation of $2M).

As a result of the reinvestment of the stock into the QOF

– There is no tax owed on the $2M for the gain in the fund $$$

– The original capital gain from the realization of the stock would now be $607K ($3M X 85% = $2,550K X 23.8%) instead of $714K because it was held for > 7 years. A savings of $107k

Keep in mind any QOF held > 10 years is eligible for no taxation on appreciation, regardless of whether it is a reinvestment or not.

Stats:

  • 35 million Americans live in Opportunity Zones
  • Average Poverty Rate over 32%
  • Median Family Income is 37% below the area or state median.
  • Unemployment is 1.6x higher than the avg.

What’s Next?

Over the next few months, the Treasury Department and Internal Revenue Service will be providing further details, including additional legal guidance, on this new incentive. Look for an update as more information becomes available as many questions linger, such as how the 10-year holding period relates to investments in 2019 and later.

Contact Us

If you have questions about how to better take advantages of this new opportunity contact us:

Adam J. Yormack, Esq
Partner
adam@eylawyers.com

Frank J. Escalante, Esq.
Partner
frank@eylawyers.com

This Escalante Yormack Law Practice Update is for informational purposes and intended to update our clients and friends on legal developments. Nothing in this Practice Update should be construed as legal advice or a legal opinion, and readers should not act upon the information contained herein.