Making money in real estate can be done through a wide array of methods. In fact, there are dozens of real estate investment strategies that can be highly profitable if implemented correctly. Moreover, the US housing market offers real estate investors several tax benefits that are not available elsewhere. In this article, we will focus on one of the most effective real estate investment strategies: Investing in real estate in Opportunity Zones. So what are Opportunity Zones? How do Opportunity Zones work? And why should you invest in one before 2020? Keep reading as we answer these questions and give you valuable tips on how to invest in Opportunity Zones.
The Importance of Investing Before the End of the Year
It should come as no surprise to most investors that real estate investments come with a myriad of tax benefits. However, few seem to realize the importance that timing plays when it comes to reducing your tax bill. Investing in any real estate venture before the end of the year gives investors the ability to deduct property taxes and interest on loans.
With Opportunity Zones, there is an extra incentive for investing before the end of 2019. The incentive in question is the deferral system that these investments offer. In fact, investors are allowed to defer their capital gains taxes until 2026. And specifically, a real estate investment held in an Opportunity Zone for at least 7 years will benefit from a 15% tax exclusion. That means the deadline is December 31st, 2019. So getting in before 2020 will enable you to maximize your tax breaks. The tax incentives of Opportunity Zones are explored in more detail further down.
A Definition of Opportunity Zones
Before showing you how to invest in Opportunity Zones, we must first define what they are. To put it simply, Opportunity Zones are distressed areas that offer real estate investors a number of tax incentives for any investment they make in the area. The goal of this initiative is to stimulate growth in economically stagnant communities by attracting capital. Needless to say, investors need to balance the benefits of such incentives with the risks that come with real estate investing in such areas. Here are some of the main features of an Opportunity Zone:
- The poverty rate in the area is substantially higher than the national average
- The median household income in the area is 20% lower than the national average
- Qualified Opportunity Zones are determined by the United States Treasury Department
It’s worth noting that there is a limit to how many Opportunity Zones a state can have. As a matter of fact, the IRS only allows a maximum of 25% of distressed areas to qualify as Opportunity Zones. And even then, the final approval is always up to the Treasury Department.
How Opportunity Zones Work
Opportunity Zones offer real estate investors a host of tax benefits. The underlying idea behind these incentives revolves around relaxing capital gains tax rules. Here is how an investor can benefit from this.
1- The ability to defer taxes
One of the perks of investing in Opportunity Zones is the ability to defer capital gains on rental property. In fact, investors can place their gains in Opportunity Zone Funds. These gains won’t be subject to taxation until the end of 2026 or when the real estate investor sells the income property.
2- An increase in the real estate investor’s basis
Besides deferring taxes, placing capital gains in Qualified Opportunity Funds offers another valuable advantage. This comes in the form of an incremental increase in the investor’s basis. More specifically, the basis will increase by 10% after 5 years of placement and as mentioned before, by 15% after 7 years.
3- New gains are not subject to taxation
The third incentive concerns long-term investments. Holding a real estate investment for more than 10 years exempts any new gains from taxation.
Benefiting from these incentives requires strict adherence to Opportunity Zone regulations. Consequently, it’s advisable that you check these regulations before investing.
How to Invest in Opportunity Zones
Now that you are familiar with how Opportunity Zones works, the next step is to outline an investment strategy. Here is how to invest in Opportunity Zones.
1- Find the right Opportunity Zones to invest in
It is important to keep in mind that not all Opportunity Zones offer the same level of upside. Some zones are situated in areas with tremendous growth potential whereas others are located in rural and less developed parts of the country. As a general rule, the safest option is to opt for zones in major housing markets. For example, a lot of California Opportunity Zones and New York Opportunity Zones are found near large metropolitan areas that boast solid fundamentals and a booming job sector. Florida Opportunity Zones are also a good option since the state is currently undergoing economic growth. Other places to consider include the Texas and Georgia real estate markets. Check the Opportunity Zones map and search for Opportunity Zones that fit these criteria.
2- Place your capital gains in a Qualified Opportunity Fund
After picking a location, the next step is to invest in a Qualified Opportunity Fund. This is the investment vehicle where you place your capital gains from the sale of an investment property. These funds invest 90% of their pooled capital in residential real estate. As for which option you should go with, stick to funds who have a long track record of profitable investments in Opportunity Zones.
3- Consider implementing a buy and hold real estate strategy
Opportunity zones are ideal for long term investment strategies. On top of the tax benefits that come with holding an investment for a long period of time, these strategies can yield a substantial return on investment. This is due to the fact that most Opportunity Zones have good growth potential. A buy and hold real estate strategy allows you to get in at rock bottom prices and ride the growth wave as the market slowly rebounds.
The Bottom Line
There is no shortage of reasons why you should invest in Opportunity Zones. The potential return of investment coupled with the immense tax benefits that they offer should be enough to prompt you to invest before 2020. Make sure to use The Mashvisor Investment Property Calculator to identify and analyze the most profitable investment opportunities in the real estate market.
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