Opportunity Zones- The Next Wave of Tax-Free Investment for Retirement
Opportunity Zones- The Next Wave of Tax-Free Investment
Deferring Gains From Current Investments- The Small Benefit
Now that we have identified the three types of buyers, lets talk about the elephant in the room that is projected to drive an estimated $250 billion dollars into these specially designated zones in the next 10 years. Opportunity Zones have been created throughout the US in areas that were identified for redevelopment. Effective January 1st, 2018, investors can now defer their gain from prior investments by investing this gain into these designated opportunity zones, provided they follow the guidelines that were put in place to encourage these investments.
Here I would like to put in a formal disclaimer that I am not a tax professional and anyone looking to take advantage of this program should seek professional tax advice from a CPA to ensure they abide by all guidelines before investing. With that said, as I understand it the guidelines are as follows.
Investments in opportunity zones can be in real estate or businesses that are located within these zones.
Investors can defer a portion of their capital gains from prior investments by re-investing their gain through a “fund” within 180 days of realizing these gains. Unlike a 1031 tax deferred exchange there is no 45 day identification of the new asset requirement and the investor can take possession of the funds within this 180 days and does not need a custodian to hold funds as one would in the 1031 process.
Any asset an investor sells and re-invests that produces a long or short term capital gain can be reinvested into these opportunity zones. Investors can pocket their basis with no penalty and invest only their gain if preferred.
As long as 90% of a businesses tangible assets are located within an opportunity zone, these businesses would qualify as investments within the opportunity zone.
The tax payer is required to invest in a “fund”, 90% of the assets the fund owns must be within an opportunity zone. However while this can be a traditional fund with hundreds of investors pooling their assets, or an investor can create a single partnership even if you were to just form your own corporation that owns 1% of this fund while personally owning 99% of this “fund” can invest in these zones and enjoy the tax benefits as long as they follow these set aside guidelines (again consult an expert when setting up this ‘fund”)
There are two timelines to keep in mind in addition to the 180 days mentioned above. At this point the investor has purchased a property or business and deferred their gain using tax deferred dollars to do so. An additional benefit is that if the investor now holds this investment for 5 years, they receive a 10% boost in their basis, meaning 10% of the gain for the prior investment is now gone, permanently tax free. If the Investor holds it for 7 years, there is another 5% boost in basis meaning 15% of the prior gain is now permanently tax free.
The remaining gain would be taxed on the investors 2027 tax return, thus to get the full advantage of gain deferral, one must invest in 2018 or 2019. Remember this taxes only the gain from the prior investment, not the basis.
This allows you to put your tax deferred investment gains to work tax free for 7 years while reducing your gains by 15% if held for this 7 year timeframe.
Now we have covered the tax deferral guidelines, lets switch gears to focus on a bigger opportunity within this program.
Tax Free Gains on Your New Investment
Investors who have reinvested their gains into a qualifying opportunity zone property or business can realize unlimited gains on this new asset if held for 10 years. This is an unbelievable opportunity that creates a built in tax free exit strategy in an area where there will likely be massive redevelopment and price appreciation. Lets take a look at the requirements that you will need to keep in mind to qualify for this program.
Within 30 months of acquisition, the investor must spend the same or more amount of money that did in acquiring the property, for improvements to the property. This eliminates most properties from contention that are in good working order and creates an environment where investors will be seeking extensive remodel projects and ground up construction projects in order to qualify for the tax incentives. While this can seem like a prohibitive guideline for some investors, I will detail in my next post why it is a massive opportunity for these investors in certain markets. KEEP IN MIND, these redevelopment funds can be borrowed, which is a huge factor to consider that will enable smaller investors to take advantage of this program. Debt can also be used for the initial investment.
This is the big one- If the investor holds the asset for 10 years, then any gain made during this 10 year period is TAX FREE.
Assets must be acquired after January 1st, 2018 to qualify.
Certain “sin” businesses are prohibited from this program such as alcohol and tobacco and other business that you may not want in your backyard anyway.
A Notable Risk for Large Funds and an Opportunity for Smaller Investors.
Something to consider if you are looking to invest in a larger fund that is starting to line up investment in these opportunity zones, is that the treasury guidelines for this program are not expected to come out until the end of this year. Because of this, the guidelines for funds that have already been raised and the 180 day window in which they are supposed to be deployed may come into question and create issues for larger funds looking to redevelop. The way I see this working out is once the guidelines are set in stone, you are going to see a massive gold rush with properties in these areas being gobbled up by these funds with massive amounts of capital, making the smaller investor less competitive and beginning to raise prices on these distressed assets that are ripe for investment.
Small Investor Gold Rush
HOWEVER, here in lies the opportunity within the next 3-6 months for smaller investors who do not have to worry about tracking the gain timeframes of hundreds of investors capital and can instead act now before this massive wave comes and drives up prices in the opportunity zone areas. The time to take on a few of these projects is right now for smaller investors who can realize the full benefits of this program before the institutional investors team up with developers, buy up all the distressed assets in the area and redevelop them which will subsequently likely cause these smaller investors property values racing higher. The community you sell this property in in 10 years will likely be in a completely different class of neighborhood than it is today as rampant redevelopment enters and further gentrifies these areas.
Opportunity Zone Strategy for the Small Investor
We have covered a lot in this post but have not set a clear path as to how a small investor who is unfamiliar in real estate development might actually be able to implement a strategy to take advantage of this program and realize a massive tax-free exit 10 years from now, while enjoying cashflow in the meantime. In tomorrow’s post I will outline how I myself and other smaller investors can do just that and include real world examples from various markets where I am planning to invest in the coming months. We will cover obtaining financing, how to identify the right properties and managing renovations without getting burned by contractors and how this 10 year strategy can create financial freedom now and in the future when investors go to sell their assets. Until then…