Opportunity Zone Funds: What They Are and How They Work

One of the key components of the 2017 tax reform legislation that didn’t receive much attention was the Investing in Opportunity Act. This created the Opportunity Zone program, which is intended to stimulate private investment and job creation in economically distressed communities rather than relying on taxpayer dollars.

Since the regulations were just finalized in recent months, this program is now getting the attention it deserves. Let’s discuss what the program entails and how Opportunity Zone Fund investments work.

What is an Opportunity Zone?

Since the tax law was passed, census tracts in every U.S. state and territory have been designated as Opportunity Zones. These areas were nominated by governors in early 2018 based on criteria such as poverty rate and median family income. The U.S. Treasury, under the authority of the IRS, then officially certified more than 8,700 areas as Opportunity Zones. These communities in both urban and rural areas are home to about 35 million residents.

The list of designated Opportunity Zones can be found here.

What is an Opportunity Zone Fund?

According to the IRS, a Qualified Opportunity Zone Fund is “an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in a Qualified Opportunity Zone.” At least 90 percent of the fund’s assets must be held in a qualified Opportunity Zone property.

Theoretically, any individual, group or business entity can create a fund by establishing a qualified entity and filling the appropriate paperwork. Projects could involve improving an existing property, developing a new property, starting a business, or funding any other qualifying local initiative.

To spur more investment, Opportunity Zone Funds were designed to be less restrictive and costly than existing programs such as the New Markets Tax Credit Program and the Low-Income Housing Tax Credit Program. The goal was also to make funds accessible to smaller investors, not just large institutions and enterprises.

How do Opportunity Zone Fund investments work?

The Economic Innovation Group estimated that $6.1 trillion in unrealized gains were sitting in stocks and mutual funds at the end of 2017, and many more unrealized gains were in other assets such as real estate and business. The idea behind this program is to motivate investors to roll over their capital gains into communities that need an economic shot in the arm.

Opportunity Zone Funds can invest in the development of a new property or the improvement of an existing property. If you invest in the improvement of an existing property, you need to invest more in the improvement than what you paid to purchase the property.

An investor who generates a capital gain from another asset has 180 days from the sale of that asset to reinvest all or a portion of that gain in an Opportunity Zone Fund. The investor can then defer tax on any prior gains invested in the Opportunity Zone Fund until December 31, 2026.

If you hold the investment for at least five years, 10 percent of the gain is not taxed.

If you hold the investment for at least seven years, 15 percent of the gain is not taxed.

If you hold the investment for at least 10 years, any appreciation in the fund from the day you invested until the day you sell is tax-free. In other words, if you invest $1 million and it grows to $5 million, the appreciation of $4 million is never taxed.

Who should be exploring Opportunity Zone Fund investments?

If you’re in the process of making a transaction that results in a gain, you should speak with your accountant or tax advisor to see if an Opportunity Zone Fund investment makes sense. If you’ve had such a transaction within the past 180 days, you still have time to take advantage of this program.

Of course, this is still a new program and the rules have only recently been finalized. Although you have a limited window to invest, you need to do your due diligence. A number of LFL Veritas clients have either inquired or are already investing in Opportunity Zone Funds. If you’d like to discuss whether this investment is a good idea for you, please contact us to schedule a consultation.

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