Originally conceived under the Obama administration, the Opportunity Zone (OZ) program was designed to attract and encourage taxpayers with significant wealth concentrations tied to stocks, real estate, family businesses, or other assets like NFTs (nonfungible tokens) and cryptocurrency. The program offers investors who commit financially long term to OZ tracts a multiyear deferral plus tax exception on post-reinvestment appreciation.
To qualify as designated opportunity zone, a community must fit certain government criteria, including being identified as economically distressed. States may nominate specific census tracts under the TCJA, which creates these opportunity zones designed to attract and encourage long-term investment in low-income communities across the U.S. Offering investors tax incentives to invest in these tracts increases spending and creates jobs. It was one of the programs initiated under 2017’s Tax Cuts and Jobs Act (TCJA).
As of September 2021, over $20 billion in equity dollars have already been invested in the OZ program, according to one national CPA firm. The number may be much higher, however, since it excludes OZ funds formed by high-net-worth (HNW) taxpayers and family offices. There are some estimates that suggest project funding has reached closer to somewhere between $80 billion and $100 billion, which was the White House’s targeted funding goal through 2027.
How It’s Helped
Traditionally, real estate developers, retailers, restaurants and even certain place-based government agencies tend to bypass economically-disadvantaged areas, including census tracts identified for OZ investment. Yet since its inception, the OZ program has seen a measurable, positive impact on economic development, home values, and job creation across the 8,700 census tracts designated nationwide as appropriate for OZ investment.
A variety of businesses have cropped up and thrived in OZ communities. For example, MITmodular, a Provo, UT-based company, converts shipping containers into transportable, affordable housing. These units have been sent to a variety of cities as a solution for housing the homeless and seasonal workers. Other companies are working in green energy and sustainability or the development of new technologies. These businesses have boosted employment, increased civic pride, driven community development, and generated solid returns for investors.
Increasing Home Values
Since its 2018 roll-out, OZ tract housing prices have experienced higher percentage increases than homes in non-OZ tracts — a boon for investor deferring capital gains into real estate projects. According to a HUD press release, one report showed that increased home values in OZ tracts benefit homes in adjacent, non-OZ tracts as well, by adding equity to homes previously seen as less valuable because of their location.
A 2021 report, Job Growth from Opportunity Zones, by the Brookings Institute, found an estimated 780,862 new jobs across diverse industries including construction and service sectors in OZ tracts. With the establishment of more OZ businesses nationwide, these jobs will continue to flourish.
To become a Qualified Business, companies must derive at least 50% of their gross income from within an OZ. The IRS’s establishment of “safe harbors” clarify how entrepreneurs can meet this requirement:
- Management, operations, and tangible property needed to generate 50% or more of gross income are located in the OZ; or
- 50% or more of the services performed by employees and independent contractors (based on hours worked or compensation paid) are performed in an OZ
Adjusting and Improving the OZ Program
On April 7, 2022, a bipartisan group of senators and representatives introduced the Opportunity Zones Transparency, Extension, and Improvement Act. The bill’s actions include:
- Extending the deferral period for qualified capital gains through 2028
- Requiring a sunset of some Opportunity Zone tract designations
- Promoting transparency by imposing new reporting requirements
- Creating the “State and Community Dynamism Fund,” a new entity intended to assist state and local governments
If enacted, it provides the most substantial update to the Opportunity Zone statute since it was enacted in 2017. The new legislation updates the OZ program and helps reinforce guardrails intended to promote transparency and prevent abuse. It also addresses issues resulting from the Treasury Department’s two-year delay in issuing relevant final regulations, which caused many investors to question the viability of investing in OZ tracts. The delay also initially limited benefits investors would receive under the OZ program — something this legislation aims to fix.
Other changes to sections 1400Z-1 and 1400Z-2 include adding reporting requirements, including an early sunset for zones with high median family incomes, and a mechanism for states to identify other qualifying census tracts as OZs.
Why You Should Invest in the OZ Program Now
Investing in an opportunity zone offers a significant benefit. Specifically, taxpayers can defer paying tax on gains from the exchange or sale of a property. Depending on the holding period, taxpayers could:
- Pay lower taxes on the originally-deferred gain
- Pay no taxes on the gain from the opportunity zone investment’s appreciation
While the 2021 deadline to take advantage of the 10% basis step-up provision has passed, the OZ program’s economics remain sound, especially for investors who’ve seen robust gains from selling a variety of assets including real estate or stocks. The OZ program remains a viable option for deferring tax on 2021’s capital gains for up to five years.
Taxpayers with large capital gains that were generated last year — if their gains are reportable on a Schedule K-1 — may still be eligible for OZ reinvestment if they do so by September 10, 2022. Those who sold assets like cryptocurrency, stocks, or land, however, have only 179 days after date of sale to reinvest.
The OZ exemption remains an attractive option for mitigating tax exposure from appreciated investments like bonds, crypto, NFTs, real estate, and stocks, especially when you consider the current inflation rate and possibility of higher federal and state taxes. While the Build Back Better (BBB) bill was defeated in its current form, it included potential tax law changes which could resurface in the future.
Those changes include limiting Sec. 1031 transactions, raising marginal tax rates, and reducing other deductions. Also a future possibility: reducing the Sec. 1202 small business stock exemption from 100% to 50%. Many CPAs and finance professionals are recommending their clients invest qualified gains into the OZ program. You can find qualified OZ locations by tract through the IRS link here.
Are you a commercial real estate investor or looking for a specific property to meet your company’s needs? We invite you to talk to the professionals at CREA United: an organization of CRE professionals from 92 firms representing all disciplines within the CRE industry, from brokers to subcontractors, financial services to security systems, interior designers to architects, movers to IT, and more.