What are Qualified Opportunity Zones?
In 2017, one of the largest overhauls to the American tax system in years was enacted.
The 2017 Tax Cuts and Jobs Act was an amendment to the Internal Revenue Code of 1986. That’s right, it took 31 years for an amendment to our tax code. As part of the 2017 amendment, the Qualified Opportunity Zones (QOZ) program was enacted to encourage economic growth in underserved communities through tax incentives for investors. It is essentially a economic development tool to encourage development in the community and job creation. The program is set to expire in December 2047.
QOZ can be nominated by the state, and the nomination is then certified by the Secretary of the U.S. Originally, only 18 states had areas considered to be opportunity zones. Now, qualified opportunity zones are located in all 50 states, five U.S. territories, and Washington, D.C.
What are the benefits of investing in QOZ?
We recently interviewed a real estate investor and developer in Nashville about opportunity zones and what they mean to the city. There are several tax benefits for investors that choose to invest in an opportunity zone that include:
- Capital gains are reinvested (within 180 days of a sale to a non-related person) into an opportunity zone for up to nine years;
- If held for five years, the tax ultimately paid on the reinvested gains is reduced by 10%. If held for seven years, that reduction is increased to 15%; and
- Gains accrued on deferred-gains funds while invested in an opportunity zone are tax-free if they are held for at least ten years.
It is important to note that all requirements must be met in order to receive the tax benefits. To comply, investments into opportunity zones must be made through Opportunity Funds (O Funds), which are organized specifically for investing in QOZ. Additionally, at least 70% of the property invested in much be in a qualified zone.
While investing and developing qualified opportunity zones seems straightforward and beneficial, there are several trickier pieces of the legislation. One of the more difficult requirements is that after an O Fund acquires a qualified zone, it must be either new or substantially improved. Substantial improvement is currently defined as investing at least as much on the improvement as was paid for the used asset. The proposed rule also currently states that the land a business sits upon does not need to be included for the “substantial improvement” amount. This ultimately reduces the required investment amounts. If the definition of “substantial improvement” seems vague, it is. Developers are eager to benefit from the program, but it seems that improvements to a site are subjective. Those investing in QOZ must be prepared to defend their investment and improvements. It also appears that legislation may further define “substantial improvements”.
Investors can now invest capital gains without immediately paying taxes on those gains and investing in those zones allow for development opportunities to grow a real estate portfolio. Investors and developers are not required to live in an opportunity zone, which allows for additional flexibility in the investment.
We will be writing follow up posts regarding QOZ in the coming weeks. You also don’t want to miss an upcoming podcast episode, where we dive deeper into these zones and what they mean for Nashville and the Middle TN area.