Earlier this year, our office was buzzing with excitement over the new real estate Opportunity Zones created by the Tax Cuts and Jobs Act (TCJA) of 2017. This section of the TCJA was created to help under-served communities attract investment capital.
Now, here at Manhattan Pacific Realty most of our business is focused on South Bay home sales, so Opportunity Zones was never a big topic of conversation among our clients. However, it seems people who normally wouldn’t be interested in this topic (local developers, homeowners, beginning investors) are now more interested since the tax benefits are significant.
This brings me to today’s blog. Due to the heightened interest, I wanted to give readers some insight on the topic, so you can decide for yourself if this opportunity is worth your consideration.
The beauty of this new law is that not only does it help under-served communities, but it also creates powerful incentives for investors to re-invest ANY capital gain (stocks, bonds, real estate, etc.). Even more compelling, investors need only to invest their gains, not funds from the basis of their original investment…much different than a 1031 exchange!
Opportunity Zones provide the following tax benefits:
- Capital gain tax deferral
- Taxable gain reduction
- Tax-free capital growth
Once you are invested in an Opportunity Zone, here is how those tax benefits work:
- Taxes are deferred on capital gains until the Opportunity Zone investment is sold or 12/31/2026, whichever is sooner. A potential tax deferment for eight years!
- If the Opportunity Zone investment is held for five years, one qualifies for an increased basis of 10% on the deferred gain. If the investment is held for seven years, one qualifies for an additional 5% on the differed gain. So a potential total of 15% in stepped-up basis.
- If the Opportunity Zone investment is held for 10 years or longer, one will NEVER pay taxes on the new capital gains from the investment.
There are detailed rules you need to follow to qualify for these Opportunity Zone incentives. Here is a quick summary of the major details:
- A Corporation or Partnership must be established as a Qualified Opportunity Fund (QOF).
- Investors must place their capital gains in the form of cash into a QOF in the 180 prior to making an Opportunity Zone investment.
- The fund must invest 90% of its assets into the Opportunity Zone in a certain time frame as well. Some of the details are still being researched.
Where are these Opportunity Zones actually located? They are located throughout the United States (use this map for reference).
As you can see there are a substantial amount of Opportunity Zones throughout Los Angeles County and California as a whole. In fact, there 274 Opportunity Zone census tracts within Los Angeles County and 874 tracts throughout the State of California.
Opportunity Zone Example
Let’s say Joe Investor purchased $50,000 worth of Amazon stock 10 years ago. Today, he decided to sell the Amazon stock, which is worth roughly $650,000.
- The gain from the sale would amount to $600,000 in capital gains for Joe Investor.
- Within the first 180 days, Joe Investor re-invested his gains into a Qualified Opportunity Fund partnership to purchase and rehab a $600,000 an apartment building to hold over the long term.
- Joe Investor’s taxable gains on $600,000 are now deferred until he sells his interest or on 12/31/2026, whichever is earlier.
- Joe Investor remains an investor in the QOF after seven years. As a result, he receives a stepped-up basis of 15% or $90,000 on his original gain.
- Additionally, Joe Investor saved and invested the cash flow from the apartment building, which ended up paying for all of his capital gains taxes due on 12/31/2026…and then some.
- Joe Investor’s original investment in the apartment building of $600,000 is now worth $1.4 million due to the area gentrifying. If he chooses to keep the investment for two more years, Joe will pay ZERO capital gains taxes on the new $800,000 profit!
This example demonstrates the power of deferred tax payments along with the possibility of lucrative tax savings on the back-end. The law is not that simple but this gives a simplified illustration as to the benefits an Opportunity Zone can offer to a prospective investor.
If you are looking to defer taxes, diversify into real estate, and potentially shelter significant long-term profits, then the new Opportunity Zones could be a wise move for you. It may not be the best fit for existing real estate owners, as a 1031 exchange allows one to invest anywhere with taxes deferred as long as they do not sell. However, equity investors, bond holders, and business owners with large gains might want to strongly consider this new tax provision!
**Please note that I am neither a CPA nor a Tax Attorney. There are many nuance laws that need to be followed in order to qualify for a QOF and the proper tax treatment (i.e. golf courses to name one). Be sure to consult with the proper professionals before moving forward with an Opportunity Zone investment.