- Deferral of capital gains tax
- Step up in basis
- Elimination of capital gains tax
These benefits are realized depending on the length of the investor’s investment in an Opportunity Fund. Here is the breakdown:
- Less than five years – deferred payment of existing capital gains until the earlier of the date that the Opportunity Fund investment if sold or EOY 2026;
- Greater than five years – benefits above 10 percent step up in the basis of the original investment of capital gains. For example, if an investor contributes $1 million to the fund and it is held for a minimum of five years, they would only owe tax on $900,000 of their gains.
- Greater than seven years – deferred payment of existing capital gains an additional five percent step up in the basis, until December 31, 2026 or the date that the Opportunity Fund investment is sold or exchanged, whichever comes first. For example, an investor would only owe tax on $850,000 of their original gains.
- Greater than 10 years – benefits of a 7-10 year investment plus investors pay no capital gains tax on the gains realized from the QOF investment.
FA: What percentage of QOZ projects are real estate development and redevelopment?
AH: It is simply too early to say what percentage will be development or redevelopment. The regulations were just released from Treasury last month and investment in this space is still in its infancy.
That said, in order to qualify investors must invest in the improvement of the asset up to the value of the building. The was added into the legislation because they did not want investors just buying a rundown asset and holding it for ten years simply to receive the tax benefit. The goal is to improve and revitalize the regions by bringing more capital and improvement to these underserved areas. This means that while we cannot predict a specific percentage of what will be new development or redevelopment, each investment will be required to meet the substantial improvement test in the regulation.
FA: Will real estate development and redevelopment projects in the zones give investors the best yield on their dollar, or are there other QOZ investment projects that you recommend?
AH: It looks like the early winner of this regulation will definitely be skewed towards real estate investments. The spirit of the legislation, however, was to provide capital for both real estate as well as operating businesses to spur economic growth.
We have a pretty clear understanding at this time of how to comply with the regulations from a real estate perspective, but we need further clarification on several items to fully understand how operating businesses will be able to take advantage of the rules.
On the real estate side for example, there are Opportunity Zones throughout areas of Los Angeles, New York, the Bay Area, etc. These regions have the ability to support the growth and revitalization in these areas and deliver returns to investors compared to other Opportunity Zones that may not yet already have the infrastructure built up.
Financial advisers will need to work with investors to identify opportunity zones that can be sustainable over the long-term and look at the risks of an investment similar to any real estate deal.