Investing in a qualified opportunity fund can be a great way to revitalize distressed communities while leveraging the tax benefits. Investing in real estate can come with a number of added advantages. But, there’s no denying that these investments are linked with a fair share of risk factors too.
But, when it comes to investing in opportunity funds, you do well for yourself while contributing to society. According to the IRS, an opportunity zone is an identified, economically-distressed community where certain kinds of investments may be eligible for favorable tax treatment.
So, if you are considering investing in opportunity zones, here’s what you need to know.
Understanding Opportunity Zones
According to the Tax Cuts and Jobs Act of 2017, you are eligible to defer your capital gains taxes if you reinvest your capital gains in a qualified opportunity zone.
Simply said, if you sell your relinquished investment property and reinvest the entire proceeds in a qualified opportunity fund, you can defer the capital gains taxes and might also completely eliminate them, given you meet certain time constraints.
What are qualified opportunity funds?
Qualified Opportunity Funds (QAFs) are usually designed to drive investors to invest in economically-distressed areas. What incentivizes the investors in investing in these funds is the tax benefit on their capital gains.
For a low-income community to be designated as an opportunity zone, the state must nominate that location. In short, the zone must have an official certification by the US Department of Treasury to be declared as a qualified opportunity zone. Once the location is certified, a qualified opportunity fund can set up investment options for investors to invest in.
Moreover, while an opportunity zone is a location where the investors invest their capital gains, an opportunity fund is simply an entity that facilitates the investment for that particular opportunity zone.
What Happens Once The Money Is Invested?
Once you invest your money in an opportunity zone, the designated qualified opportunity fund will use this money to invest in properties within that opportunity zone. In short, the properties will help the zone to be developed through substantial improvements. However, the fund must make these improvements within a 30-month period, and the improvements must be equivalent to the fair market value of that property at the time of investment.
For instance, if an opportunity fund invested in a building worth $2 million, they would get 30 months to make a minimum improvement of worth $2 million.
The basic intention behind incentivizing investors to invest in opportunity zones is the hope for economic growth in that particular zone. Moreover, investing in opportunity zones can create greater employment opportunities, diverse housing options and regular business activity.
In fact, according to a 2020 study by the Urban Institute, investing in opportunity zones has made a greater community impact by reducing poverty.
What Are The Benefits Of Investing In Opportunity Zones?
In addition to contributing positively to the growth of a distressed location, investing in opportunity zones comes with personal benefits too. For starters, you can defer the taxes on your capital gains and diversify your portfolio.
And, if we get deep into this, investing in opportunity zones comes with two tax benefits-
- You can defer the capital gains tax on your original proceed until the 2026 tax year. This means you wouldn’t have to pay the capital gains taxes until you file the 2026 tax return in the year 2027.
- Another benefit: the longer you hold your investment, the more tax benefits you will receive. This means that if you hold your investment for 5 years, you’ll get 10% of the cost basis, which would exclude you from paying taxes on 10% of your capital gains. Moreover, if you hold your investment for 7 years, you’ll get a 15% leverage. Lastly, if you held your investment for 10 years, you will owe no capital gains in any additional appreciation beyond 2027.
Is This Worth The Risk?
Investing in an opportunity zone can be a great way to do good for society and diversify your own investment portfolio. However, to make things work, you must follow certain regulations and have appropriate paperwork when working with a qualified opportunity fund.
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