Opportunity Zones are census tracts with “below national average” incomes, nominated by governors and certified by the U.S. Department of the Treasury, into which investors can now put capital to work financing new projects and enterprises in exchange for certain federal capital gains tax advantages. The Treasury has certified 8700 Opportunity Zones, which is twelve percent of U.S. census tracts, many of which already attract businesses and investments. Under the 2017 Tax Cuts and Jobs Act, the IRS and Treasury Department now allows investors to defer the tax on all, or a portion, of their gain in any asset class, if that gain is invested in a Qualified Opportunity Zone. The goal of this initiative is to gentrify low-income and rural areas by stimulating investments that will provide increased housing and jobs…and investors are now equipped with a powerful new tool to catalyze growth. Given the significant interest among investors, it is possible that this new tax incentive could attract tens of billions of dollars in private capital, possibly making this one of the largest economic development initiatives in U.S. history.
When the Investing in Opportunity Act — the legislation that led to Opportunity Zones — was first introduced in Congress in 2016, The Economic Innovation Group conducted an analysis of the Federal Reserve’s Survey of Consumer Finances and Financial Accounts of the United States data to calculate that U.S. households were sitting on $2.3 trillion in unrealized capital gains in stocks and mutual funds alone at the end of 2015. Fast-forward to the end of 2017, and that figure climbed to $3.8 trillion. U.S. corporations were conservatively estimated to hold $2.3 trillion in unrealized capital gains on their books at the end of 2017. Added together, the pool of potential capital eligible for reinvestment in Opportunity Zones climbs to a total of $6.1 trillion. And that’s not including investment gains outside the universe of stocks and mutual funds.
The Qualified Opportunity Zone program has created an opportunity in what is known as a Qualified Opportunity Zone Fund (QOZF). In a QOZF, any capital gain one has, whether generated from appreciation real estate, stock, bonds, gold, or even art, can be invested into these designated opportunity zones to get tax deferral or ultimate tax reduction. For example, an early investor in a highly appreciated, publicly-traded tech company may wish to sell some or all of the stock in an effort to diversify or to lock in gains from the investment. Until these zones were created, there were limited options available to avoid paying taxes on non-real estate related profits while keeping control of the gains.
In an opportunity zone fund, only the gain from sale (not the principal) is required to be invested in the zone, rather than the gain plus the original investment, as required in a 1031 exchange. In a 1031 exchange, taxation is deferred for life if continually reinvested in real estate. Tax treatment in QOZ investments differs from 1031 exchanges tax treatment in several ways. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged. Investors have 180 days to reinvest capital gains, after the sale of the asset, into a QOZ project.