Opportunity Zones were originally devised by the Economic Innovation Group, a non-profit focused on empowering entrepreneurs and investors to “forge a more dynamic economy throughout America.” The program was meant to support existing businesses, grow new businesses, and finance needed real estate projects in low-income communities impacted by the Great Recession.In 2018, Treasury Secretary Steve Mnuchin estimated that Opportunity Zones could attract as much as $100 billion in private capital. And although the investment climate has changed dramatically since then, largely in part because of COVID-19, at least $10 billion has been invested in Opportunity Zones, according to the Urban Land Institute. And of the 186 investments that the Economic Innovation Group has identified, about 145 are in real estate. Understandably, the coronavirus pandemic slowed both Opportunity Zone real estate improvements and Qualified Opportunity Fund (QOF) investments. However, with the stock market recently reaching all-time highs, QOFs are back in the headlines. But why? How does the stock market impact QOFs?
Because reinvesting money earned on the sale of an asset into a QOF means deferring—and potentially reducing—your capital gains tax bill.
Selling stock (or any other asset) is a taxable event. Say you bought 100 shares of Tesla stock at the beginning of 2020 for $100/share. On August 31st, each share was worth just under $500 ($498.32 to be exact). Assuming you sold all your shares that day to an unrelated person, you would have earned $49,832, $39,832 over your initial $10,000 investment. That extra income is now subject to capital gains taxes. However, if you had elected to invest that $39,832 into a QOF, you not only got the opportunity to reap additional gains down the road but you could avoid paying taxes on any new gains resulting from the QOF investment. Simultaneously, you might be able to defer and potentially reduce the tax payments on your original gain.
Here are a few numbers to remember when thinking about investing in a QOF:
8,700: There are roughly 8,700 Opportunity Zones across the US, located in both rural areas and the core of major cities. 180: Once your gain is recognized, you have 180 days to invest any capital gains into a QOF in order to defer the capital gains tax on the invested capital. This deferral lasts until the sale of your QOF investment or until December 31, 2026, whichever is sooner, with payment due in 2027. There are some inclusionary events that can trigger the requirement to repay part or all of the gains tax earlier than that.10: Provided your investment is held for at least ten years, you would not need to pay federal capital gains taxes on any gains produced by the QOF investment.5: Any QOF investment that is held for at least five years by the time the deferred gain is considered realized–December 31, 2026 at the latest–is eligible to receive a 10% step up in basis prior to paying the deferred taxes. This means paying capital gains tax on only 90% of the original deferred capital gains. Starting December 31st, 2020, you have just one year left in order to meet that five-year hold requirement.
What else do investors need to know about QOFs?
Remember that you should evaluate QOFs the same way you review any other potential investment opportunity–by focusing on the strength of the underlying investment itself. The tax breaks are the cherry on top, the deal still needs to be sound and make sense for your portfolio. Keep in mind that you’ll need to submit an IRS form electing to treat the investment as a Qualified Opportunity Zone investment in order to take advantage of the tax benefits.Given that real estate is an illiquid investment, it’s also important to remember that your capital will be locked up for the duration of the hold period, which in the case of a QOF could be ten years. Unlike stocks or bonds, you don’t have control over when you sell your investment–that is up to the sponsor. QOFs give you the opportunity to have a meaningful impact on a community, driving much-needed economic growth. President-elect Joe Biden’s Opportunity Zone reform agendaseeks to encourage “opportunity funds to partner with non-profit or community-oriented organizations and jointly produce a community-benefit plan for each investment” with a focus on job creation and directing financial benefits to households in the zones. If you’re the kind of investor that is looking to do well, while also doing good, an investment in Opportunity Zones might be a worthwhile addition to your portfolio. One of our most recent Opportunity Zone deals oversubscribed in minutes and we expect to have more on the CrowdStreet Marketplace this month. Browse the latest deals and see if one is right for your portfolio.
