If you’re a real estate investor and you want to take advantage of the tax benefits that exist in the real estate market, then you should consider investing in Opportunity Zones.
Investing in Opportunity Zones can be a great way to gain several tax benefits on your real estate investment, especially when you’re trying to reinvest the gains you’ve made from selling a property and you want to purchase another one to generate some more profits.
The Opportunity Zones program is a new program that aims to accelerate the development of low-income communities by offering tax incentives and benefits to attract investors to these areas.
Real estate investors, in particular, will find investing in Opportunity Zones a great way to defer the gains taxes from any previous deals that they’ve made and to reinvest the amount in new properties in Opportunity Zones to generate more profits at a larger tax discount.
In this article, I will briefly explain what the Opportunity Zones program is, how to take advantage of it, and what are the benefits that can be gained from investing in Opportunity Zones.
Opportunity Zones: What Are They?
“Opportunity Zones are a new community development program established by Congress in the Tax Cuts and Jobs Act of 2017 to encourage long-term investments in low-income urban and rural communities nationwide. The Opportunity Zones program provides a tax incentive for investors to re-invest their unrealized capital gains into Opportunity Funds that are dedicated to investing into Opportunity Zones designated by the chief executives of every U.S. state or territory.”
While there have been other similar programs attempted in the past, such as the Empowerment Zone and the Renewal Communities programs, the new Opportunity Zones program is different and more wide-ranging.
For example, real estate investors will find that the new Opportunity Zones program has included residential rental property businesses, while the previous programs did not. This opens up a whole new level of possibilities for real estate investors, and especially beginner investors who are looking to do their first re-investment after owning their first rental.
The inclusion of additional types of businesses in the Opportunity Zones program can effectively lower the risk of investing through Opportunity Funds, and it can be a great way to diversify your investment portfolio while still benefiting from the tax advantages presented by this program.
Investing in Opportunity Zones: Tax Benefits
So, what are the tax benefits that are presented with investing in Opportunity Zones?
There are three main tax benefits that are included in the Opportunity Zones program:
- If the investor holds their Opportunity Zone fund shares for five years, their deferred gain taxes are reduced by 10%.
- If the investor holds their Opportunity Zone fund shares for seven years, their deferred gain taxes are reduced by another 5% (total 15%).
- If the investor holds their Opportunity Zone fund shares for ten years, they can exclude the taxes on any appreciation in the value of their Opportunity Zone fund shares.
As you see, there are three different levels of advantages that can be gained by investing in Opportunity Zones depending on the period of time that you hold on to your Opportunity Zone fund shares.
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The way this works is as follows:
You sell a property for profits. You have 180 days to re-invest the profits in Opportunity Zones to postpone paying taxes on these profits. You can re-invest this money in an Opportunity Zone by purchasing shares for the amount in the Opportunity Zone fund of your choice (you can distribute your money across multiple Opportunity Zone funds).
Now, your money is re-invested, and you gain tax benefits depending on how long you hold on to your new investment. Additionally, you have effectively postponed your capital gain taxes until 10 years in the future, by which time your tax benefits will have reached their maximum potential, and you can exclude from tax any appreciation in the value of your new investment.
Example on Investing in Opportunity Zones
To give you an example of how this would work when investing in Opportunity Zones:
Assume that a person owns an investment property. That person sold the property and made $200,000 in profits or capital gains. Normally, they would need to pay capital gain taxes on the $200,000 profits that they made. However, by investing in Opportunity Zones they can postpone paying their capital gains taxes for 10 years.
That person has now invested their $200,000 in an Opportunity Zone fund. If they hold their fund shares for five years, they will get a 10% reduction on their deferred gain, so now their taxable gains are $180,000.
If they hold their shares for 2 additional years (7 years in total), their deferred gain is reduced by another 5% and is now $171,000. This means that by holding the Opportunity Zone fund shares for 7 years, that investor has effectively reduced the amount of taxable capital gains from $200,000 to $171,000, and $29,000 of the original profits are now tax-free.
However, if they hold their shares for an additional 3 years period (10 years in total), they can exclude any appreciation in the value of the Opportunity Zone fund shares. So, if by that point their shares have appreciated in value and are worth $300,000, the investor can exclude their entire $100,000 gains from their capital gains taxes.
Investing in Opportunity Zones: FAQs
Here are some of the most notable FAQs about investing in Opportunity Zones:
Q1: Do I need to live in an Opportunity Zone to take advantage of the tax benefits?
A1: No. You can get the tax benefits even if you don’t live, work or have a business in an Opportunity Zone. All you need to do is invest in a Qualified Opportunity Fund.
Q2: I am interested in investing in an Opportunity Zone. Is there a list of Opportunity Zones available?
A2: Yes. The current list of approved Opportunity Zones can be found at Opportunity Zones Resources. This list will continue to be updated as more Opportunity Zones are approved.
Q3: I sold an investment for gain in 2018, and, during the 180-day period beginning on the date of the sale, I invested the amount of the gain in a Qualified Opportunity Fund. Can I defer paying tax on that gain?
A3: Yes. If during the 180-day period you had invested in one or more Qualified Opportunity Funds, only an amount that was less than your entire gain, you may still elect to defer paying tax on part of the gain, up to the amount that you invested in that way.
Q4: How do I elect to defer my gain on the sale of an investment property?
A4: You may make an election to defer the gain, in whole or in part, when filing your 2018 Federal Income Tax return in 2019 (that is, you may make the election on the return on which the tax on that gain would be due if you do not defer it).
Q5: Can I still elect to defer tax on that gain if I have already filed my 2017 tax return?
A5: Yes. You may elect to defer the gain, but you will need to file an amended 2017 return. As part of that amended return, you will follow the election procedure described in the answer to the preceding question.
Just like doing a 1031 exchange, investing in Opportunity Zones can help you reduce the amount of capital gains taxes drastically and postpone paying these taxes for a later date.
This creates multiple new opportunities for creative real estate investors who rely on these methods to maximize their returns and minimize their taxes. Additionally, and since the new Opportunity Zones program has included residential rental property businesses, beginner real estate investors can now take advantage of the tax benefits of this program without having to invest in high-risk investments, and they can continue growing their rental property business while helping in the development of low-income areas in the U.S.
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If you’re looking to analyze the investment opportunity for rental properties in an Opportunity Zone, make sure to check out Mashvisor’s data and analytics for that area to see the amount of profits that can be made from investing in that Opportunity Zone.