Understanding Opportunity Zones
Real Hope or Just Hype?
When the Investing in Opportunity Act became law in December 2017, the intent was to encourage long-term investment in low-income communities by providing tax incentives for investors. The first Opportunity Zones were designated in April 2018 and covered parts of 18 states; now, there are more than 8,700 Opportunity Zones in all 50 states as well as in Washington, D.C., and five U.S. territories.
One year into the program, we analyze its promises, perks, and pitfalls, and offer tips on how to make the most of this community investment tool.
What Are Opportunity Zones?
An Opportunity Zone is an economically distressed community in which new investments may be eligible for preferential tax treatment. These distressed census tracts are characterized by a high rate of poverty, low median family income, and high rate of unemployment.
In order to select the communities that would benefit the most from new investments, the federal government sought local input. The governor or chief executive of each state or territory submitted zone nominations to the Treasury Department, which then certified and designated the official Opportunity Zones.
The goal? To incentivize investors to fund long-term projects in high-need areas. Specifically, Opportunity Zones provide a tax incentive for investors to reinvest unrealized capital gains—the profits from the sale of a property or investment—into Opportunity Funds.
What Are Opportunity Funds?
An Opportunity Fund is a privately managed investment vehicle, organized as a corporation or partnership, with the specific purpose of investing in qualified Opportunity Zone property. The fund must hold at least 90% of its assets in Opportunity Zones.
Keep in mind that in order to qualify for the new tax incentives, you must invest through a qualified Opportunity Fund. You cannot invest your capital gains directly in an Opportunity Zone business or property and still qualify for the incentives.
Tax Incentives for Investors
By investing in an Opportunity Fund, you can enjoy capital gains tax deferral, reduction, or even permanent exclusion. While you can choose to temporarily defer inclusion in taxable income for capital gains reinvested in an Opportunity Fund until you dispose of the investment (on or before December 31, 2026), there are greater rewards for holding onto the investment:
If you retain the investment for at least five years, you can exclude 10% of the taxable gains from the original investment amount.If you retain the investment for at least seven years, you can exclude 15% of the taxable gains from the original investment amount.If you retain the investment for at least 10 years, you can exclude 15% of the taxable gains from the original investment amount and 100% of the taxable gains of the Opportunity Fund investment.
The longer you hold onto the Opportunity Zone investment, the greater the reward. According to the Economic Innovation Group, if you reinvested a capital gain of $100 in an Opportunity Fund in 2018, by 2028 you would have $44 more than if you had invested that money in a traditional stock portfolio.
In other words, this opportunity is for patient investors. If you have capital gains and some time, an Opportunity Fund can be a worthwhile investment.
But is the program beneficial for communities as well?
The Benefits of Opportunity Zones
Proponents of the program hope it can undo some of the damage of last century's “urban renewal," which, in some cases, destroyed historic structures and erected parking lots in their place. New investments can boost both the economy and the employment in a depressed area.
Plus, the lack of traditional rules and government oversight for these investments means that innovators in a variety of industries can use the tax incentives to be responsive to the needs of various communities. For example, investors may choose to make equity investments in new or expanding businesses, or even invest directly in qualifying property.
The Risks of Opportunity Zones
Detractors, however, fear that the lack of oversight will lead to minimal improvement in the zones. Currently, the legislation does not delineate specific outcomes to help determine whether the investments will lead to real change. It also does not include a requirement for data reporting.
An Ethical Approach to Opportunity Zone Investments
The key to ensuring your investment is beneficial to the community as well as your portfolio is to consult with the community itself.
To find out more about investments in other areas, and see Opportunity Zone tracts throughout the United States, click here.
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