May 2, 2019
By now, you may have heard the term Opportunity Zone (OZ) mentioned as tax season got under way. But what are OZ’s and, most importantly, how do they affect decision-making in commercial real estate?
What is an Opportunity Zone?
For a while this year, many details regarding the OZ classifications were yet to be finalized or publicized. However, the IRS just released some initial guidelines earlier this month to help investors and business leaders start developing their investment strategy and business plans.
The newly-created OZ program is included in the Tax Cuts and Jobs Act of 2017 and is intended to encourage private investment in low-income or economically disadvantaged areas across the country. According to Cherry Bekaert, an Atlanta-based accounting firm, OZ’s are important to consider because, “The tax incentives provide investors with an opportunity to defer recognition of gains on sales of assets, permanently reduce a portion of the deferred gain to be recognized and permanently exempt any future gain with respect to reinvested proceeds, by reinvesting the gain in a Qualified Opportunity Fund (“QOF”), an investment vehicle specifically focused on making investments in Qualified Opportunity Zone (“QOZ”) businesses and/or property, allowing for greater diversification than other tax deferral mechanisms.”
As a participating state, Governor Cooper and the NC Department of Commerce designated tracts of land in every county as OZ’s, including some in the Triangle, as shown in the map below.
What does this mean for businesses in the Triangle?
Businesses and real estate projects in the Triangle can qualify for the OZ tax incentives, with increasing benefits the longer the property in the OZ is owned.
There are two major benefits business can take advantage of. Firstly, you can defer paying or owing any capital gains tax until the time you sell the property you buy in the OZ or at the latest, 12/31/2026. If you retain the property in the OZ for more than 5 years, your capital gains tax burden is reduced by 10% and, if you keep it more than 7 years, your capital gain tax burden is reduced by 15%. This means you only pay capital gains tax on 85% from the sale of your original property.
The second benefit according to the IRS website, is “if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.” So, if you hold onto a property in the OZ for 10 years, you could potentially avoid ALL of the capital gains from the time you purchased the property in the OZ to the time you sold that property. Over 10 years, these tax incentives could total huge savings, without having to perform a 1031 exchange with the subject property or business.
These guidelines also extend to qualified businesses opened in OZ’s as well. The capital used to start the business MUST be pulled from another investment fund or realized capital gains.
Why does this matter?
As a real estate investor or entrepreneur, the tax plan is incentivizing you to invest in OZ’s and share in the lifting of financially burdened areas of your community. By adhering to these new tax standards, businesses have the opportunity to both boost disadvantaged neighborhoods in the Triangle, as well as to take advantage of a great opportunity for wealth creation.
Cherry Bekaert, “Opportunity Zones: A New Investment Opportunity” (2018).
IRS.gov, “Opportunity Zones Frequently Asked Questions” (2019).