For the majority of investors, the single most difficult part of putting together an Opportunity Zone Fund is rooted in the complexity of the regulations; however, whereas those complex regulations would benefit from clearer guidelines, they’re not exactly scaring away investors. In fact, in a recent survey, more than half of investors listed tax incentives as their primary motivation to invest in one or more of the over 8,700 Opportunity Zones across the country. After all, the overall policy behind Opportunity Zones was created to provide incentives to investors to invest capital gains dollars in low income census tracts.
But what exactly are the tax incentives driving investors toward Opportunity Zone Funds? Erin Gillespie, the founder of Madison Street Strategies, an economic development consulting firm, laid them out for participants of NES Financial’s free “Insider Insights: How Opportunity Zones Can Work For You” webinar, which was hosted on August 14th.
Here are the three major Opportunity Zone Fund incentives:
1. A Temporary, 7-Year Capital Gains Deferral
If someone invests in an Opportunity Zone, she or he can defer paying any capital gains from the investment until the sale of the new investment or until December 31, 2026, whichever date comes first. For example, if an investor sells some stock or a piece of property and ends up with $1 million in capital gains, those taxes won’t be due for another seven years. “That is a very small but good incentive for people to invest,” said Gillespie.
2. Step-Up Tax Benefits of Opportunity Zones
If an investor invests in an Opportunity Zone by the end of 2019 and holds onto that investment for five years, her or his liable taxes will be reduced by 10 percent. If the investor holds the investment for seven years, that step-up increases to 15 percent. That means that if someone invests $1 million and holds onto it for the next seven years, that person will pay taxes on $850,000 in 2026 instead of the original $1 million investment.
3. Permanent Exclusion From Capital Gains
If an investor holds an investment in an Opportunity Fund for 10 years, she or he won’t have to pay any post acquisition gains made over that time, except for any taxes due in 2026. That means if someone invests $1 million in a multi-family market rate housing project and the value soars to $5 million by 2029, that $4 million difference accrued during that time frame will be completely tax-free. “That is the huge benefit of the program and really the piece that most investors are looking for,” said Gillespie.
According to Gillespie, it’s that last incentive that’s most attractive to investors. As Q3 winds down, Gillespie anticipates another big deployment of money before the end of the year toward Opportunity Zones; however, she warns investors not to rush into a hasty deal in order to meet the forthcoming 2019 cutoff. “[Investing in an] Opportunity Zone does not make a bad deal good,” she said, “Rushing into a bad deal … for a very small incentive is not worth it.”
Instead, Gillespie recommends doing the due diligence required to identify great investment opportunities, asking the right questions, and planning to lock into the 10-year permanent exclusion hold.
Erin participated in the NES Financial webinar on August 14. Click here to hear what else she has to say about Opportunity Zones.