What Is An Opportunity Zone In Real Estate? An Investor’s Guide
If you’re a real estate investor looking for a new investment property, you may be interested in exploring opportunity zones. But what is an opportunity zone and how does it work?
Opportunity zones are designed to create new jobs and increase growth in economically disadvantaged neighborhoods. By investing in an opportunity zone, you can give back to the community and receive certain tax benefits in return.
Opportunity Zones Explained
Opportunity zones were created under the Tax Cuts and Jobs Act (TCJA) of 2017 as an economic development tool. The program allows individuals and businesses to invest in distressed communities to increase economic growth and job opportunities.
An opportunity zone is a geographic area that’s been identified as a low-income census tract. To qualify as such, these communities must have a median income that’s 80% less than the neighboring areas. Or a neighborhood can qualify if it has an average poverty rate of 20% or higher.
Governors nominate these communities, and the requests are reviewed and approved by the Secretary of the Treasury. The U.S. Department of Housing and Urban Development (HUD) administers the program and coordinates with several other government agencies.
In addition to opportunity zones, the TCJA also created opportunity funds. These investment resources are designed to facilitate economic opportunity and free up capital to be used in opportunity zones.
Finding Opportunity Zones
There are 8,764 opportunity zones located across the U.S. The best way to find a qualified opportunity zone is by checking the map provided on by the HUD. This interactive map can help you determine how local community needs can align with your own interests.
How Do Opportunity Zones Work?
A qualified opportunity zone is an economically distressed community that could benefit from revitalization. Investors are given tax incentives to invest in these areas and spur new economic growth.
Governors across the U.S. nominate opportunity zones and they are designated by the U.S. Department of the Treasury. These designated zones are areas that have lower incomes, higher unemployment, and higher poverty rates.
If you’re interested in investing in an opportunity zone, you should check the HUD’s opportunity zone map.
Opportunity Zone Investment Qualifications
To invest in an opportunity zone, you’ll start by placing eligible capital gains in a qualified opportunity fund. Eligible capital gains are any income received from the sale of stocks, bonds, real estate or private businesses.
However, these gains must be put in a qualified opportunity fund within 180 days of the sale. Of course, you can invest the proceeds from a sale of any asset, but you won’t receive the same tax benefits. It can be helpful to consult with an attorney during this process.
What Are Qualified Opportunity Funds?
A qualified opportunity fund is an investment vehicle that invests in a qualified opportunity zone. Here are the steps you must follow to create and maintain an opportunity fund:
- Invest 90% of your capital in a qualified opportunity zone
- File a federal tax return as a partnership, corporation or LLC
- The opportunity zone must be located within one of the 50 states, the District of Columbia or a federally recognized Indian tribal government.
In order to be considered a qualified investment, the opportunity fund can invest in property or companies in the surrounding area. An example of an eligible investment would be investing in a business in the area.
Qualified opportunity funds come with substantial tax benefits. And they are also a great way to invest in a local community that could use some help.
Opportunity Zone Tax Benefits
Opportunity zones are tax incentives designed to encourage individuals and businesses to invest in low-income communities. Any corporation or individual with capital gains can qualify for the program.
Here are some of the main tax benefits you can receive:
- Temporarily defer taxes on previously earned capital gains: You can have the option to put existing assets you owe capital gains on into an opportunity fund. You won’t owe any capital gains taxes until 2026, or until the asset is disposed of. To qualify for the deferral, any gains have to be reinvested within 180 days of when they’re recognized as taxable income.
- Increase of original basis: If you place capital gains in an opportunity fund for at least 5 years, the basis on the original investment will increase by 10%. If the assets are held for at least 7 years, your basis will increase 15%.
- Permanent exclusion on capital gains taxes: Any investments held for at least 10 years are permanently excluded from capital gains taxes.
Opportunity Zone Investment Example
Let’s say a taxpayer sells a real estate property which results in a $3 million capital gain. That individual has an opportunity to invest that money in an opportunity zone fund within 180 days of the sale.
By placing the funds in a qualified opportunity zone fund, the investor avoids paying capital gains taxes. This can result in substantial tax savings.
Benefits Of Opportunity Zones
Potential investors and low-income communities stand to benefit from opportunity zones. Economically distressed areas can bring in new investors to invest capital and revitalize the community.
And investors benefit from the additional tax savings. Here are some of the biggest benefits of opportunity zones:
- Additional taxes: Opportunity zones can bring in additional tax dollars from the businesses investing in that area. And your residential tax base could grow as people move to the area to be closer to where they work.
- Improve the community: The additional tax dollars could be used to build up infrastructure and services in the area. This in turn would help make moving to the area more attractive for those looking to relocate.
- Opportunities for expansion: From a business or development perspective, the tax benefits themselves could make Opportunity Zones attractive targets for expansion.
- Opportunities to partner with other businesses: Because of the tax benefits associated with investing, businesses may find it easier to partner with other businesses on investments.
The Bottom Line
Investing in an opportunity zone comes with substantial benefits for potential investors. You can defer or reduce the amount you end up paying in capital gains tax. And if you keep the property for 10 years or more, you won’t owe any taxes on the appreciation in value.
Before you can invest in an opportunity zone, you must invest in an opportunity fund. To be considered a qualified opportunity fund, 90% of the capital must be invested in a qualified opportunity zone.
Real estate is one of the best investment opportunities available and it comes with numerous tax benefits. If you’re ready to get started, you can apply for a loan with Rocket Mortgage® today.