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How Investing in Opportunity Zones Works

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Today, we have a guest post from CrowdStreet, our affiliate partner. I started investing in real estate crowdfunding with them earlier this year and I’ve had a great experience so far. Recently, I noticed some projects are designated as “Opportunity Zone.” I don’t know anything about these so I asked CrowdStreet to tell us more about them. These projects sound like a good way to reduce tax. Check it out.

How Investing in Opportunity Zones Works

The goal of the Opportunity Zone program, created as part of the 2017 Tax Cuts and Jobs Act,   was to attract private capital for long-term investment in low-income communities by providing meaningful capital gains tax benefits to investors in the form of tax deferral, reduction, and elimination.

By investing your qualifying capital gains–meaning gains earned by selling stocks, a business, real estate, etc.–into a Qualified Opportunity Fund (QOF), it’s possible to obtain the following tax benefits:

  • Tax deferral of your reinvested capital gains;
  • Tax reduction of those reinvested capital gains (via a step-up in basis) if certain criteria are met–a 10% reduction if the investment is held for 5 years and 15% reduction if the investment is held for 7 years; and
  • The elimination of capital gains tax for gains resulting from the sale of your QOF investment (provided the investment is held for a minimum of 10 years).

These tax benefits would be on top of any potential dividends you may earn while invested in the property.

How to Invest in Opportunity Zones.

Unlike other direct commercial real estate investments, in order to get any of the tax benefits associated with investing in an Opportunity Zone, you have to invest your qualifying capital gains into a QOF and not directly into a property in the QOZ.

A QOF needs to meet certain requirements, the biggest one is that it must invest in Qualified Opportunity Zone Property, which can include Qualified Opportunity Zone Stock (a domestic corporation that qualifies as a Qualified Opportunity Zone Business), Qualified Opportunity Zone Partnership (domestic partnership that qualifies as a Qualified Opportunity Zone Business), or a Qualified Opportunity Zone Business Property.

A Qualified Opportunity Zone Business Property could consist of one or more real estate development or redevelopment projects. To qualify, the property also has to be substantially improved, meaning the basis (essentially the value) of the property needs to double within a 30 month period. This means that all QOZ real estate projects are going to be considered “Opportunistic,” which is the riskiest segment of commercial real estate investment opportunities. These kinds of projects often target higher rates of return for the investors but also come with more risks–permitting issues, construction delays, the rising cost of materials, finding tenants–that could impact the success of the project.

While almost any asset could be designated a Qualified Opportunity Zone Business Property, our research report explains why multifamily properties are expected to be a key asset in QOFs, thanks in part to the higher proportion of small to medium-sized multifamily properties that typically cater to lower-income residents in these economically underserved communities.

What Makes QOFs Different

An important feature of most QOF investments is that they are intentionally long-term. In order to receive the full tax benefits–both the capital gain reduction and exclusion–you have to hold the QOF investment for at least 10 years.

It is also important to note that, unlike other commercial real estate investments, you have to invest your qualifying capital gains into a QOF within a certain time frame, generally 180 days from the date of the sale generating capital gains (although this time frame may be different for different types of capital gains). There are various nuances in the proposed regulations that make it important for you to work with a tax advisor to ensure you will be eligible to get the full tax benefits of investing in a QOF.

 When a Fund is Finally a Fund

Contrary to what the term “fund” implies, to date, most real estate-focused QOFs have contained just one property. While investors can reap the potential tax benefits by investing in single asset QOFs (remember, you have to invest in a fund to invest in the property), the main benefits of investing in a true real estate-focused fund, including diversification across other assets, sponsors, geographies, and risk mitigation, have not been part of the mix.

But the most recent round of proposed regulations contains a provision that makes it easier for QOFs to invest in multiple properties, allowing for a more diversified QOF portfolio with a single investment. (It’s important to note that taxpayers cannot totally rely on this provision until the regulations are finalized, which adds another element of risk to the investment.)

 Reporting suggests that American households have $3.8 trillion and corporations have $2.3 trillion in unrealized capital gains. All of that money could flow into Opportunity Zones, provided investors find the kinds of opportunities they are looking for.

CrowdStreet has published several Opportunity Zone-based projects on our Marketplace this year, one of which ended up our biggest individual raise ever. We expect to see a large chunk of that $6.1 trillion moves into QOFs in 2020 as more and more investors take advantage of this unique investment opportunity.

By: Thomas McDonald

Sign up for a free account at CrowdStreet to check out their projects. CrowdStreet specializes in commercial properties across the USA. You can invest in apartments, self-storage, strip malls, office buildings, medical offices, and more. Real estate is a great way to diversify your investment portfolio and grow your passive income.

Retire by 40 is an affiliate partner of CrowdStreet.

This article was written by an employee of CrowdStreet, Inc. (“CrowdStreet”) and has been prepared solely for informational purposes. CrowdStreet is not a registered broker-dealer or investment adviser.  Nothing herein should be construed as an offer, recommendation, or solicitation to buy or sell any security or investment product issued by CrowdStreet or otherwise. This article is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation or needs of any investor. All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future performance. All investors should consider such factors in consultation with a professional advisor of their choosing when deciding if an investment is appropriate.

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Joe started Retire by 40 in 2010 to figure out how to retire early. He spent 16 years working in computer design and enjoyed the technical work immensely. However, the job became too stressful and Joe retired from his engineering career to become a stay-at-home dad/blogger at 38. Today, he blogs about financial independence, early retirement, investing, and living a frugal lifestyle.

Passive income is the key to early retirement. This year, Joe is increasing his investment in real estate with CrowdStreet. He can invest in projects across the U.S. and diversify his real estate portfolio. There are many interesting projects available so sign up and check them out.

Joe also highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help DIY investors analyze their portfolio and plan for retirement.

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{ 14 comments… add one }
  • Kathe November 2, 2019, 4:30 pm

    I’ve been wondering about Opportunity Zones. I didn’t understand much of the article, but what I got out of it was you can’t just buy a building in one of these areas, fix it up and get the credits.
    It’s hugely complicated and best left for REIT type investments, if done at all.
    Thanks for clearing that up!

  • Journeytoretire November 2, 2019, 7:28 am

    I’ve seen Qualified Opportunity Zone funds in my job (Tax CPA). They are very complex investments and probably not available for everyday investors. The capital commitment to get into some of these real estate deals is pretty steep, so I’ve only seen major Private Equity / Hedge funds be able to close on deals. The cost of tax advice on these products alone might outweigh the benefits.

    Ironically, the Opportunity zones were outlined using the 2010 Census. So places like Long Island City, Queens was included in the zone as a place that needs “redevelopment”. We all know now that the LIC area has been gentrified and real estate has sky-rocket, so funds and corporations (i.e. Amazon) tried to get in for a major tax break in a highly demanded area.

    As a few other commenters suggested – another barrier to entry is the lockup period, i.e. you need to hold the investment for 10 years to reap the benefits, which is why it’s best left to the Private Equity funds to go for the properties since they have a long term commitment.

  • Mike H. October 31, 2019, 2:25 pm

    I’ve done in-depth research on Opportunity Zones for my job, and honestly I don’t think this post is in the FIRE genre. Opportunity Zones aren’t really for the average individual investor, and the benefits over a simple (“simple” lol) 1031 exchange are…debatable.

    Fun fact: Opportunity Zones are the brainchild of Sean Parker (yes, THAT Sean Parker), and received exactly ZERO minutes of floor time or debate as the 2017 tax bill was being rammed through the legislation process.

    There’s a fair number of Qualified Opportunity Funds out there trying to drum up business – there’s been a lot less business in this area than was initially anticipated. So this feels like a sales pitch to me. The tax advantages of investing in Opportunity Zones are undeniable, but the investment profile is, again, debatable. It’s almost certainly not for the average lower-than-millionaire individual investor (YMMV).

    If you happen upon an O.Z. investment while browsing your real estate crowdfunding potentials, ask yourself whether you can keep your money stationary that long regardless of what the ROI turns into. Also, the future of Opportunity Zones is unclear past 2026.

    Sorry for the essay. I’m actually a big fan of this subject…from an institutional standpoint.

    • retirebyforty November 1, 2019, 8:34 am

      Thank you for your input. I really appreciate it from an expert.
      I haven’t seen a compelling project yet so I haven’t invested. Good to know about 2026 too. That’s coming up soon for this kind of investment timeline. QOF sounds like a better fit for a REIT company or something like that.

  • Lazy Man and Money October 31, 2019, 10:43 am

    I understood about 3% of that article. At least the author maximized the use of “Q” on his keyboard.

    I looked into opportunity zones a little while back and there’s one property that is local. I didn’t get too much further as I don’t have the capital to invest right now. Still, it does seem to be an amazing once in a lifetime investing opportunity.

    • retirebyforty October 31, 2019, 1:34 pm

      This guest post is pretty dry. I had a hard time with it too.
      The last time I looked, they had one opportunity zone project up. It doesn’t look attractive to me.
      The yield isn’t any higher than other projects. Just tax saving isn’t attractive enough. I’d need a good yield too. Hopefully, there will be some better projects in the future.

  • jim October 31, 2019, 9:53 am

    Minor FYI :
    “and 15% reduction if the investment is held for 7 years”
    The deadline on these things is 2026. So thats 7 years from now. If you don’t get into an OZF by the end of this year then the 15% reduction isn’t possible.
    Thats not a good reason to rush into an OFZ investment, just point it out..

    Personally I haven’t seen anything too compelling for OZF investments. Its all qualified investor stuff and not large diversified publicly traded funds.

    • retirebyforty October 31, 2019, 1:35 pm

      Thanks for your input. I haven’t seen an attractive opportunity zone investment either.
      These projects aren’t very common. I’ll keep looking.

  • Sally October 31, 2019, 6:16 am

    wow, this seems really shakey to me. probably, many horror stories of things going wrong

    • retirebyforty November 2, 2019, 4:46 pm

      I think you’re right. Opportunity zone investment is more risky. Most people should stick with regular projects.

  • Xrayvsn October 31, 2019, 3:27 am

    After the sale of my medical building (which will trigger an incredibly large capital gains tax bill for this year’s return) I looked at ways to shield the gains and QOZ was something that intrigued me.

    I ended up not going with it because it was a little more risky in my opinion than the other more conservative properties I have been investing in. First it is ground up building rather than an established property so there is inherent risk in that. And of course the opportunity zoned areas were supposed to be in economically challenged/depressed areas so that worried me (although I later found out that some locations zoned as QOZ were actually in desired up and coming neighborhoods.

    I think I have enough money in real estate with carryover depreciation that regardless I should take a big bite out my capital gains tax anyway but QOZ was quite tempting because of the benefits you mention

    • retirebyforty October 31, 2019, 1:36 pm

      I think you’re right. The QOZ investments are more risky. That’s why the government is giving some incentives to investors.
      It’ll have to be a really good investment or else the tax saving isn’t worth it.

  • Financial Freedom Countdown October 31, 2019, 12:01 am

    Opportunity Zone is great for tax advantages. However need to vet each deal individually and not let the tax tail wag the dog. I wrote about my experience losing over 50% on a crowd funded real estate platform and what lessons I learned from the experience. My checklist is working great so far on other residential projects. Fingers crossed.

    • retirebyforty October 31, 2019, 1:37 pm

      Thanks for your input. The biggest problem with RE crowdfunding is the company screening the projects. CrowdStreet has a very good track record so far, but the economy was great. Hopefully, they’ll keep it up.

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