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A Guide to Investing in an Opportunity Zone

TLDR

What You Need To Know

  • The purpose of opportunity zones is to “spur economic growth and job creation in low-income communities while providing tax benefits to investors”[1]
  • Investing in opportunity zones can come with tax benefits, like temporarily deferring taxes on realized capital gains
  • Currently, you can defer your capital gains with a qualified opportunity zone fund until the end of the 2026 tax year

Contents

There’s a common misconception that investing and helping others are mutually exclusive goals. But you can make a potentially profitable investment while contributing to positive change by investing in opportunity zones.

Opportunity zones are an economic development tool that offers a potential win-win scenario to investors who can qualify for tax benefits while helping under-invested neighborhoods throughout the U.S.

A qualified opportunity zone fund (or QOZ fund) lets you contribute to the economic development of distressed communities while enjoying accompanying tax benefits and a potential return on your investment.

Qualified opportunity zone investing can be a great way to combine impact investing and tax benefits – but is it right for you? Continue reading to learn more about opportunity zone investments, their pros and cons and how to invest in an opportunity zone fund.

What Are Qualified Opportunity Zones?

Opportunity zones were introduced with the passage of the 2017 Tax Cuts and Jobs Act. According to the IRS, the purpose of opportunity zones is to “spur economic growth and job creation in low-income communities while providing tax benefits to investors.”[1]

Opportunity zones are census tracts or areas nominated by states and certified by the Treasury Department. Today, there are nearly 9,000 qualified opportunity zones across the 50 states, Washington, D.C., and five U.S. territories.[2] Twelve percent of U.S. census tracts are opportunity zones and roughly 23% of opportunity zones are in rural areas.[3] 

98%

of Puerto Rico was designated an opportunity zone.[4]

What Are Qualified Opportunity Funds?

Qualified opportunity funds are investment vehicles that let you invest money in opportunity zones. To qualify as a qualified opportunity fund, at least 90% of the fund’s assets must remain invested in opportunity zone properties and investments. If the fund’s investments drop below the 90% threshold, the fund will pay a penalty each month it fails to meet the threshold.[5]

Like other investment funds, qualified opportunity funds:

  • Can increase or decrease in value 
  • Can pay income to its investors (though it may take several years before the properties begin to generate income
  • Don’t guarantee income generation or a return on your investment
  • Employ their own strategies and areas of focus

How Do Opportunity Zone Investments Work?

In theory, a qualified opportunity fund will drive community development by investing in local businesses and properties. Qualified opportunity funds use the money raised from investors to invest in[6]:

  • Qualified opportunity zone property: This can be any real estate purchased within a qualified opportunity zone. After a property is purchased, the fund has 30 months to make substantial improvements to the property that are, according to the IRS, at least equal to the price the fund paid for the property. 
  • Qualified opportunity zone business: A business must demonstrate that its physical location is owned or leased in a qualified opportunity zone and at least 50% of its total gross income comes from business conducted in the opportunity zone.
  • Qualified opportunity zone investments: A qualified opportunity fund can also invest in other funds and investment vehicles that are invested in a qualified opportunity zone. 

A qualified investment fund can invest in more than one opportunity zone. In fact, a fund can invest in multiple opportunity zones at the same time. 

What Are the Tax Benefits for Investors?

The opportunity zone program offers tax savings on realized capital gains ranging from 10% – 100%. How much can you save? For opportunity zone investments kept in a qualified fund for 5 years, your basis (the amount of your investment) will increase by 10% of the deferred gain. After 7 years, your basis cost savings will increase by another 5%.[5]

To avoid paying capital gains tax, opportunity zone investments must remain in a qualified opportunity fund for at least 10 years. 

Investors choose which opportunity zones they want to invest in and look for a qualified opportunity fund that invests in those areas.

What Are the Requirements for Investing in Opportunity Funds?

Although the goal of a qualified opportunity fund is to make it easier for investors to move money into developing, lower-income communities, investors must navigate some red tape.

What is the minimum investment amount?

Each fund sets its minimums, and there is no cap on how much you can invest in a qualified opportunity fund.

While almost any taxpayer can invest in qualified opportunity funds, the IRS lays out certain requirements around how and when you can defer your capital gains.

What are the IRS rules regarding opportunity zone investments?

The key rule is you can’t invest the money you earn from your job to get a tax deferral. Only capital gains that would be taxed as federal income are eligible. Here are other IRS guidelines:

  • You can use the recognized gains from the sale of an asset (like stocks or bonds). 
  • You can reinvest your gains in the qualified opportunity fund within 180 days of selling the asset.[7]
  • You must meet annual reporting requirements for a qualified opportunity fund investment. This includes filing Form 8997, which lets the IRS know about your qualified opportunity zone investment and intent to defer gains.[8]

How Do You Invest in an Opportunity Zone?

You don’t have to live in a qualified opportunity zone to invest in opportunity zones. Like most investments, qualified opportunity funds use brokers to promote and manage investments in their funds. 

If you’re interested, talk to your financial advisor and tax professional to see if investing in a qualified opportunity fund aligns with your tax and financial plans. 

What Are the Risks and Rewards of Investing in Opportunity Zones?

Is an opportunity zone a good investment? That depends. An investment in opportunity zones has both risks and rewards. 

PROS of Investing in Opportunity Zones👍

Upside potential on your investment
You contribute to developing communities
Significant tax savings if your money is invested long enough
The option to defer your capital gains taxes

CONS of Investing in Opportunity Zones 👎

Increased risk of investment losses
Strict time limits on when you can reinvest to defer taxes
Requires lengthy time commitment to take advantage of tax savings

How long can you invest in a qualified opportunity zone fund?

Currently, you can defer your capital gains with a qualified opportunity zone fund until the end of the 2026 tax year. Reform legislation is currently being considered that would extend the deferral to 2028, but it may change the nature of the program.[9]

It’s an Opportunity To Invest in Under-Resourced Communities

Your investment in a qualified opportunity fund can help neighborhoods while delivering tax breaks and the possibility of strong returns. While opportunity zone investing can help grow economically disadvantaged communities, it’s considered a high-risk investment. Make sure you understand the risks before saying yes.

  1. Internal Revenue Service. “Opportunity Zones.” Retrieved June 2022 from https://www.irs.gov/credits-deductions/businesses/opportunity-zones

  2. Internal Revenue Service. “Designated Qualified Opportunity Zones Under Internal Revenue Code § 1400Z-2 Notice 2018-48.” Retrieved June 2022 from https://www.irs.gov/pub/irs-drop/n-18-48.pdf

  3. U.S. Economic Development Administration. “Opportunity Zones.” Retrieved June 2022 from https://eda.gov/ceds/opportunity-zones.htm

  4. Department of Economic Development and Commerce. “Opportunity Zones.” Retrieved June 2022 from https://www.ddec.pr.gov/en/opportunity-zones/

  5. Internal Revenue Service. “Invest in a Qualified Opportunity Fund.” Retrieved June 2022 from https://www.irs.gov/credits-deductions/businesses/invest-in-a-qualified-opportunity-fund#

  6. Internal Revenue Service. “Investing in Qualified Opportunity Funds – Final Regulations (TD 9889).” Retrieved June 2022 from https://www.irs.gov/pub/irs-drop/td-9889.pdf

  7. Internal Revenue Service. “Certify and Maintain a Qualified Opportunity Fund.” Retrieved June 2022 from https://www.irs.gov/credits-deductions/businesses/certify-and-maintain-a-qualified-opportunity-fund#

  8. Internal Revenue Service. “About Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments.” Retrieved June 2022 from https://www.irs.gov/forms-pubs/about-form-8997

  9. U.S. Congress. “S.4065 – 117th Congress (2021-2022): Opportunity Zones Transparency, Extension, and Improvement Act.” Retrieved June 2022 from https://www.congress.gov/bill/117th-congress/senate-bill/4065

ICYMI

In Case You Missed It

  1. Qualified opportunity funds are investment vehicles that allow you to invest money in opportunity zones

  2. To qualify as a qualified opportunity fund, at least 90% of the fund’s assets must remain invested in opportunity zone properties and investments

  3. While opportunity zone investing can help grow economically disadvantaged communities, it’s considered a high-risk investment

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