What is an opportunity zone? This is a recent phrase that people have started hearing about, but very few people understand it. Fortunately, my two guests today and have been actively learning about it the for the last four months.
My guests are Terrance Doyle and Brandon Gossett of the Value Add Real Estate Company. I asked them to come on the podcast to share what they have learned about Opportunity Zones.
An opportunity zone is a tax incentive from the 2017 tax law to incentive development and redevelopment in certain areas designated by the states. Some people have described them like a 1031 exchange, but better. It allows a person to take capital gains that are not real estate, such as the sale of stocks, and invest it into real estate.
Connect with Terrance and Brandon at http://www.thevareco.com
Follow Terrance on Instagram to see their flips at @terrancedoyle
Below are the notes from Terrance and Brandon.
Opportunity Zone Summary:
Everyone always wants to defer taxes as much as possible, this is the governments way of allowing anyone to defer taxes until 2026, and get a discount on the capital gains tax of 15%, so even if it just stopped there it’s better than a 1031 exchange however with the added benefit of being able to sell the property and not pay any capital gains on anything above the total basis.
The key to this incentive is the deferral coupled with the ability to not pay any tax on the gain after 10 years
It is a purely development and redevelopment play, it does not suit minor rehabs. The government is looking for ground up development and significant redevelopment in order to qualify for the tax incentive.
What is an opportunity zone?
It's a tax incentive part of the new tax reform to incentivize development and redevelopment in specific low-income community that were hand-picked by each state governor and designated as qualified opportunity zone. The US treasury department approved 126 tracts as of 3 months ago. There are additional tracks being considered but as of now that is all that has been officially approved. Opportunity zones have been approved in 20 states and 4 territories as of May, with several other states that have been said to be applying late.
Why is it better or different from a 1031 exchange / how is it worse?
1031 has been around for a long time and appears will be around for a long time to come, and also offers investors the ability to defer taxes on capital gains until the owner passes away or stops buying like properties. With 1031 there is no discount in capital gain taxes based on time that the property is held, it simply defers taxes by continuing to buy new like assetts when another is sold. What makes the O zone incentive more valuable to long term investors is the ability to get a discount on the gain after 7 years and then not pay any gain once the property is held for 10 years and sold. The discount of held 7 years is 15% the discount if held a minimum of 5 years is 10%. I would say the one advantage 1031 has is that there is no need to set up a separate “fund” to invest, and that there is no time complement besides holding a minimum of 1 year to be able to sell a property and purchase another one and still defer taxes. With O zone’s you must hold the property a minimum of 5 years to get a 10% discount, 7 years for 15% discount and 10 years to sell with no capital gain on the basis. The other major advantage to 1031 is that ONLY the capital gain needs to be invested into the O zone not the entire proceeds of the sale. Example if you sell a property for a million and 1031 the entire million needs to be reinvested to qualify for 1031 in O zone only the capital gain from the previous basis needs to be invested in order to qualify for the deferral.
“For example, if the sale of property for $1 million in 2018 generates gain of $200,000, a taxpayer may elect to defer the $200,000 gain by investing $200,000 into a qualified opportunity fund. The excess $800,000 is unrestricted and irrelevant to the deferral. By statute, a taxpayer has 180 days after the recognition of gain to reinvest into a qualified fund to qualify for deferral – similar to 1031 rules but without restrictions of a qualified intermediary.” - Scott Grimm
How does it work?
An investor has a taxable event which triggers a capital gain by sale of a property, business, stock or any asset. They then have 180 days to put the capital gain into a qualified opportunity zone fund which simply means an LLC or company that is set up solely for the purpose of O zone investing. (Defined as 90% of assetts invested in the O zone, checked by IRS on bi annual basis) After the initial 180 days from the taxable event the investor then has another 180 days to invest the funds into an opportunity zone property or business. The last major hurdle is that 30 months from the purchase of the property the total basis of the purchase must be reinvested into the improvement of the property. Example if I buy a piece of land for 1m, I need to have invested 1m into improving the land and building before 2.5 years from the date the investor purchases the property. This is a way for the IRS to ensure that real development is going on in the these areas and investors aren’t just buying land and sitting on it. There has to be a real investment and improvement made to every property.
Who does this tax code help?
This tax code offers help to low income communities that are in need of redevelopment to spur growth and revitalization. It also offers help to businesses in these low income areas that can also qualify for O zone investment, although we haven’t touched on it today, there is a section of the code that allows for investing in businesses that operate in these areas or to start new businesses in these areas. So both of these groups stand to benefit greatly. The obvious group is anyone that sells a business or stock or piece of real estate with a large capital gain, they now have the ability to defer for up to 7 years and get a sizable discount on that gain. We also think that experienced developers have a significant opportunity to benefit from this tax code, due to their experience and economies of scale to develop faster and more affordably than others.
How can I take advantage of this tax incentive?
The beautiful thing about this incentive is that anyone can invest into the O zone. There are multiple large groups that offer the ability to invest or you can set up your own o zone fund and start the process yourself. ( we may want to leave this question out)
Where are the opportunity zones in Denver?
Lakewood, Englewood, Denver, to name a few. The full map is at https://choosecolorado.com/opportunity-zones/
Why would the government offer this kind of incentive?
The government is assuming that in order to spark investment into certain low income areas of the country there needs to a proverbial “carrot” to get investors and developers motivated enough to offset the risk of investing in some of these “less attractive areas” of the city. They also realize that if new businesses are created in these areas, it can be very beneficial for the community long term which will offset the short term loss of income for the government. It is also speculation that while the stock market is at an all time high with billions of dollars in unrealized gains this could be one way to trigger investors to realize a portion of those gains to invest in their communities and the government knows they will @ minimum get 90% of the capital gain in 5 years or 85% of the gain in 7 years.
Scott Grimm's article is at https://crej.com/news/opportunity-zones-tax-reforms-least-publicized-incentive/