Active investors are always on the lookout for the latest and better investment vehicles. They are always watching for investment opportunities around them so that they can increase their income potential and reduce taxes on capital gains. One of these opportunities is readily seen in the newly-formed investment in Opportunity Zones. This was established by the Tax Cuts and Jobs Act of December 22, 2017.
This new incentive allows each state in the United States and its territories to name up to 25 percent of its total low-income census tracts as opportunity zone candidates. This new program has the potential to attract investment capital into low-income areas of different states in America. As NYtimes, reports, this program is already generating a lot of interest among investors as a way of deferring and reducing capital gains.
Investing in these Zones will offer some tax benefits to qualified investors when they invest their unrealized capital gains from other businesses into these areas. This program is meant to spur increase in economic activity in the selected areas.What are Opportunity Zones?
Opportunity Zones are selected places in the urban, rural, and suburban, areas identified by the government as underdeveloped in all the states of the united states and its territories. The government allow private investors to use the profit they made from the sale of an investment (capital gain) or their businesses elsewhere and invest into these zones.
The aim of giving the tax incentive to investors is to encourage them to improve economic growth within the underdeveloped communities. These communities are called tracts and they are usually low income or high poverty areas in the states. The first groups (or tracts) were established in June 2018 and cover different parts of 18 states. At present, there are 8,700 identified best opportunity zone all over the United states.
After the tax law was passed in 2017, governors were given 90 days to nominate a quarter of the eligible zones in their state. Many states tried to give equal importance to areas that were in greatest need and places that would be more likely to attract investments. The resulting zone included some surprising places like the arts district in LA. The U.S. Treasury Department then certified the selections. From the certified areas, the governors where now asked to pick 25% that will be included in the zones.
The communities that were chosen as tracks for the opportunity zone was chosen based on their incomes before the state governors will now nominate 25% of them. According to an October 19, 2018 article in the Wall Street Journal, “the program has bipartisan roots and Congress deliberately created an open-ended program with few restrictions, with the idea of relying on market forces and the new tax incentive to guide development.” The governors of all 50 states and five territories were tasked to identify communities that would benefit most from designation as an Opportunity Zone.
The IRS released a list of qualified Opportunity Zones on June 14, 2018, identified by their census tract number. The list encompassed 8,700 tracts covering 12% of the U.S. land mass. Concentration varies among states based on size and socioeconomics. For instance, almost all chosen areas of Puerto Rico (861 tracts in total) was designated as an Opportunity Zone, whereas the County of Los Angeles had only 274 definite qualifying tracts.
Opportunity Zones are in both rural and urban settings, and there is at least one in each major city. Even though rates of poverty and unemployment are materially above average, the nomination process also allowed for 5% of tracts to be non-Low-Income Communities so long as the tract was adjacent or contiguous to a Low-Income Community. The investors are supposed to come in, conduct their businesses and reinvest into more business or new property developments located in the opportunity zone areas to continue to enjoy tax reductions.
The aim of this program is to drive more investment in under-served areas. We know that venture capital investment is critical to the economic growth and opportunity of a nation, this article shows the opportunity zones can help businesses in an area.
There has been an irregular economic growth in the U.S. A few cities are booming, while others from rural counties to aging Rust Belt towns get left behind. Giving investors an incentive to plow some of their $6 trillion in unrealized capital gains into these distressed communities could help jump-start growth, create jobs and lift incomes. Almost all of the places chosen for the opportunity zones have poverty rates north of 20% or family incomes lower than 80% of the state or metro median.
To be able invest in an Opportunity Zone, you need to go through a qualified opportunity fund that is held by a corporation or partnership. A Qualified Opportunity Fund is an investment vehicle that uses its investors’ capital gains from a previous investment to fund the development of Opportunity Zone properties. The fund managers that are working with investors will go a long way in making this program success by receiving the needed support from people. Those managers who align their efforts with the intent of the Opportunity Zone policy can signal the best investment options among many, and in the process reduce financial risk for other investors and channel money to where it's most needed.
An investor in an opportunity zone will be able to defer and even reduce their federal tax liability on the sale of assets if they place their gains from those sales into the zone. The fund will be used to support investments in small businesses and real estate within the Zones, which will improve those communities and the quality of life for residents.
The program was developed to be flexible, and give chance a range of different types of investments. There is no authorized cap on the amount of capital that could be made available through Opportunity Zone investments unlike other federal tax credit programs and previous intervention programs. The revenue impact from the program is expected to increase over time.
In essence, the plan gives investors two different advantages. The first one is that they can defer and reduce capital gains they’ve earned elsewhere by investing those proceeds in an opportunity zone. The second one is that they pay no capital gains on any opportunity-zone investment they hold for at least a decade.
If you’re an investor, you’ll find that the Opportunity Zone program offers you several unique benefits, such as:
Imagine this scenario, you sold an investment in 2019 and wanted to use $100,000 of the capital gain to reinvest in an Opportunity Zone. To defer paying Capital Gains Tax on the $100,000, you have 180 days to roll it over into a Qualified Opportunity Fund. Now, let’s see what happens if you stayed invested for 5, or 7 years.
5 Years: If you stay for 5 years and sell your investment in 2024. The program allows you to reduce your Original Gain Tax basis by 10%. So, you only have to pay tax on $90,000 of the $100,000 Original Gain and on the appreciated amount.
7 Years: If you wait and you sell after 7 years, in 2026, the program allows you to reduce your Original Gain Tax basis by 15%. So, you only have to pay tax on $85,000 of the $100,000 Original Gain and on the appreciated amount.
There have been concerns on whether this program will succeed in helping less disadvantaged zones in the US. These fears came about due to the low success rates seen in some of the previous similar programs.
A study by Mckinsey suggested that a good way to ensure this program doesn’t witness high failure rate is for the state and local governments who have played two roles which will be critical in facilitating opportunity-zone investments. The roles will be to educate investors and other stakeholders and providing implementation support.
It’s not every day that you see a policy that incites a lot of interest and excitement across the public, private and non-profit sectors like the Opportunity Zone program. That is why smart investors need to take full advantage of it now.
If you as an investor wants to have impact and for the latest, best thing on the horizon, bread, opportunity zones may well be the best vehicle you can use to achieve those dreams.