Opportunity Zones are a new community development program established by Congress in the Tax Cut and Jobs Act on December 2017. Due to the relative newness of this program, most real estate investors are not familiar with or understand what an Opportunity Zone is. If this is your first time hearing about the Opportunity Zones program, the first thing you should know is that it has the power to transform real estate investments. Read more to learn what exactly an Opportunity Zone is, how the program works, and the benefit that you, as a real estate investor, will enjoy from investing in an Opportunity Zone.
What Is an Opportunity Zone?
To put it simply, an Opportunity Zone is a community that is economically-distressed and in which new investments could be qualified for favorable tax treatments. Designated areas (or localities) qualify as Opportunity Zones under certain conditions. They must be nominated for that designation by their state, and that nomination must be certified by the Secretary of the U.S. Treasury. Since the passing of the law, there are now more than 8,700 designated Opportunity Zones in all 50 states and US territories.
The purpose of the Opportunity Zones program is to spur economic development and create jobs in these distressed communities by providing tax benefits to real estate investors. Moreover, an Opportunity Zone is designed to encourage long-term investments in low-income urban and rural communities across the US housing market.
While there have been similar programs in the past, like the “Empowerment Zone Program” and the “Renewal Communities Program”, this new program is different. For one thing, it includes residential rental properties which, as you’ll see below, has offered great benefits for real estate investors – especially beginners. Moreover, unlike other existing programs, the Opportunity Zone program is less restrictive, less costly, and less reliant upon government agencies to function.
Why Should You Invest in an Opportunity Zone?
As mentioned, an Opportunity Zone aims to motivate economic development by providing tax benefits and incentives to real estate investors. How? Through investing in an Opportunity Fund. An Opportunity Fund is a US partnership or corporation that invests at least 90% of its holdings in one or more Qualified Opportunity Zones. A Qualified Opportunity Zone is defined as any of the following:
- Partnership interests in businesses that operate in an Opportunity Zone
- Stock ownership in businesses that conduct most or all of their operations within an Opportunity Zone
- Property such as real estate located within an Opportunity Zone
Thus, an Opportunity Fund invests in Opportunity Zones and, in exchange, offers a real estate investor several tax incentives, both immediately and over the long-term. If you’re looking to analyze the investment opportunity for rental properties in an Opportunity Zone, check out Mashvisor’s data and analytics for that area to estimate the potential profits you can make from investing in that Opportunity Zone.
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Tax Benefits of Investing in Opportunity Zones
There are many benefits to investing in real estate properties in general, including tax benefits. If you’re interested in learning more about this, read this “The Tax Benefits of Real Estate Investments.” Investing in real estate through the Opportunity Zone program, on the other hand, adds on to these benefits.
Property investors can reap tax deferral benefits at the beginning of their investment. Those who invest in the Opportunity Fund for at least 10 years, however, can defer and reduce their initial capital gains tax AND receive a permanent exclusion from taxable income of capital gains on profits when selling their Opportunity Fund investment.
Therefore, the longer that property investors hold their investment, the more income they are able to exclude from capital gains tax and the greater the tax benefits are. If a real estate investor holds his investment for at least 5 years, he can reduce his liability on his capital gain tax by 10%. If you hold the investment in the Opportunity Zone for a minimum of 7 years, you’ll get to reduce an additional 5% from taxation (a total of 15%).
Furthermore, those who hold their investment for 10 years can expect to pay NO capital gain tax and exclude the taxation on any appreciation in the value of their Opportunity Fund. This is because, as we said, earnings from Opportunity Zone investments can qualify for permanent exclusion of capital gains.
Additional Benefits to Investing in an Opportunity Zone
We mentioned earlier that the new Opportunity Zones program has included residential rental properties, something that previous programs did not. The purpose of this is to provide more possibilities for property investors looking to re-invest the profits from their first real estate investment. This can be a great way to grow and diversify your investment portfolio. Furthermore, this lowers the risks of investing in Opportunity Funds while still allowing you to enjoy the tax benefits of the program.
This is how the process goes. After selling an investment property for profits, a real estate investor will have 180 days to re-invest in an Opportunity Zone to defer paying capital gain tax on these profits. He/she can re-invest through buying shares in the Opportunity Fund or even distribute the money across a number of funds. The latter option, in fact, is smart because it can offer exposure to various markets across the country. After a real estate investor re-invests the profits, he/she now gains tax benefits depending on how long he/she holds on to the investment.
Here’s another reason to invest in an Opportunity Zone: not only will this program give you access to more investments, but to larger and better investments than what you would otherwise be able to access on your own. By pooling capital from thousands of real estate investors, an Opportunity Fund is also able to pursue not one, but several types of real estate development projects.
The Bottom Line
The Opportunity Zone program offers a set of capital gains tax incentives and other advantages that have the power to transform the real estate investment industry. We advise property investors to understand tax reforms and choose a qualified Opportunity Fund when going for this investment strategy. In addition, be sure to consult with a tax adviser or financial expert to explain further how investing in Opportunity Zones will affect your business and the challenges that you may face.
Don’t forget to check out Mashvisor’s data and analytics for an Opportunity Zone to estimate the potential return on investment and profits you can make from investing in it. To learn more about how we help property investors make faster and smarter real estate investment decisions, click here.
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