Opportunity zones were started in 2017, and they were mentioned in many headlines at the time. Opportunity zones were created to encourage investors to focus on low-income areas, and these investors received tax benefits in exchange for improving these communities. But this initiative was met with mixed reception.
They say hindsight is 20/20, so let’s dive into what opportunity zones are, and what both sides of the debate have to say about them.
Only THESE Areas Can Be An Opportunity Zone…
An opportunity zone is usually a low-income community that would benefit from revitalization through investments. Opportunity zones have been around since 2017, when the Tax Cuts and Job Act was passed. This legislation created opportunity zones to encourage economic growth and job creation in these communities.
In order for an area to qualify as an opportunity zone, they need to meet the income criteria set by the IRS.These include:
20% or higher poverty rate
In any area that qualifies, a maximum of 25% can be nominated to be an opportunity zone.
The purpose of opportunity zones is to encourage investors to take the unrealized capital gains and invest it into long-term projects that will promote economic activity in impoverished areas. To do this, investors place their money into an opportunity fund.
But What Is A Qualified Opportunity Fund?
If you want to invest in an opportunity zone, then you need to invest through a qualified opportunity fund. This investment vehicle is formed to invest in assets located in an opportunity zone. Qualified opportunity funds are set up as corporations or partnerships. So let’s say A Brothers LLC wants to become a qualified opportunity fund. They would need to self-certify by filing Form 8996 along with its federal income tax each year.
After they receive this qualified status, qualified opportunity funds are required to invest a minimum of 90% of their assets in assigned opportunity zones in order to take advantage of the tax benefits associated.
It is widely accepted that the best way to benefit from investing in an opportunity fund is to have an investment horizon of at least ten years. This means that those looking for short-term gains, or access to their capital in less than a decade, might find that opportunity zone investing is not a good fit for them. This is mainly due to the tax incentives, which we’ll explain below.
Do Good AND Pay Less Taxes?
**This is not financial or tax advise**
Yes, that’s right - there are tax benefits on top of the altruistic ones to society. Investors in a qualified opportunity fund can defer their tax liability on capital gains from previous investments. In other words, if an investor puts the money they receive from capital gains into a qualified opportunity fund in 180 days or less from the date of sale, they qualify for tax payment deferral until the sale of the opportunity fund or December 31, 2026, depending on which comes first.
The benefits to investing in an opportunity fund vary depending on how long you keep your money in the fund. For 5 years, an investor receives a 10% reduction in tax liability. For 7 years, they receive a 15% reduction in tax liability. If they keep it in for 10 years, they get this 15% discount and they don’t have to pay any capital gains tax on any supplemental appreciation their investment has seen during the time they’ve been in the fund.
The benefits of investing in an opportunity zone are clear now. Many advocates of opportunity zones also note the way this program can tackle the harm of urban renewal which may have resulted in unequal development. These investments provide the fundamental resources needed in these disadvantaged communities through economic stimulation and more job opportunities.
But there are also opponents of opportunity zones, who believe the intentions behind opportunity zones are more sinister and corrupt than they might seem.
The Dark Side of Opportunity Zones?
Critics of opportunity zones argue that this program is simply a scheme to help the rich pay less taxes, and is not really about making a long-term improvement to these historically disadvantaged areas.
Many also cite the lack of oversight as a weakness of opportunity zones. They argue that this can lead to lackluster street-level improvements, since existing policies fail to outline specific guidelines for what qualifies as “real change” to these communities.
However, the truth of the matter is that the tax incentives offered to investors who commit to long-term investments in opportunity zones results in more capital and resources flowing into these areas. This wouldn’t happen without the opportunity zone, but because of the tax incentives put in place, new businesses, jobs, and infrastructure are created to promote economic growth. Less regulation means more opportunities for investors to be creative with how they invest their money in these zones.
Now, it’s important to also mention that not every property in an opportunity zone is eligible. A property must be a new construction, or the opportunity fund must invest the same amount or more into the property to improve its condition than it did to buy it if the property is a rehab project. This only applies to the price of the property itself, not the land.
Investors who want to start their own opportunity fund need to have a minimum $1 million in assets, since it can be expensive to start a fund and the costs can diminish the attractiveness of the tax savings.
Opportunity or Obstruction?
Opportunity zones and the debate surrounding them involves both bright spots and challenges. These zones were established to breathe new life into struggling neighborhoods, but we’d be remiss to not acknowledge the controversy surrounding them. Moving forward, it’s critical to find that middle ground - tapping into the opportunities and potential these zones offer while addressing their valid criticisms. Striking this balance allows investors to help more communities thrive and create lasting change.