By Tomi Jo Lynch of SVN | Gold Dust Commercial Advisors
Opportunity zones are a new means by which real estate investors can defer capital gains tax, while simultaneously investing in low income communities. Opportunity zones are part of the recent Tax Cuts and Job Act signed on December 22, 2017 and offer investors an alternative to the traditional 1031 exchanges. The provision was largely supported by both sides of the aisle, therefore there was little to no media coverage about this new provision. Many of the rules and regulations are still being interpreted and defined by the IRS.
Six things you should know about Opportunity Zones:
- The purpose is to deploy long term capital to low income communities in order to spur economic development.
- Opportunity zones are defined by the Governor of each state and are subject to guidelines outlined in the Tax Cuts Job Act. For example, they must be located in low income census tracts or adjacent to low income census tracts, the areas must show some signs of positive momentum and job growth or have older housing stock that needs renovation.
- Investors have 180 days from the sale of an asset to reinvest in an Opportunity Zone. Unlike 1031 exchanges there are no intermediaries, complex timelines, or the need to pre-identify the replacement asset. Opportunity zones are not intended to replace 1031 exchanges and do not suit all investor profiles.
- In order to ensure the capital is deployed in these areas for the long term, there is an additional incentive of a step up in basis based on your hold period. There is a 10% step up in basis after a 5 year hold, a 15% step up in basis after 7 years, and the full benefit can be realized by complete deferment of any gains after the asset is held for 10 years.
- An important caveat for real estate investors is the Substantial Improvement clause, which states that an asset must have substantial improvements made to the property within the 30 months following acquisition of the asset and that the total capital expenditures made must exceed the purchase price of the property. For example, a cash flowing shopping center with little deferred maintenance located in an opportunity zone would not qualify as it does not require any large capital expenditures. However, a vacant industrial building with an acre of yard that an investor would like to re-purpose into multi-unit housing might qualify nicely.
- Last of all, there is a list of prohibited uses, such as liquor stores, massage parlors, racetracks, suntan facilities, and golf courses, that would negate the ability to qualify for the tax benefits of an opportunity zone investment.
This legislation is very new, and the rules of the road will continue to be defined and clarified over the coming years. For more information on opportunity zones, talk to your experienced commercial real estate advisor, accountant, and attorney.
**This article is not to be construed as legal or tax advice. Anyone interested in pursuing an opportunity zone investment should consult with an attorney and accountant.