Last week I had the opportunity to attend a lecture on Opportunity Zones. At the lecture we learned what Opportunity Zones are and why we should invest in them. If you’re unfamiliar with Opportunity Zones they are a new community development tool established by Congress in the Tax Cuts and Jobs Act of 2017. This new tool is designed to drive long-term capital to low-income communities. But how? Well, the new law provides a federal tax incentive for investors to re-invest their capital gains into Opportunity Funds, which are specialized vehicles dedicated to investing in designated low-income areas. Now, before you go throwing all of your capital gains into an Opportunity Fund, here’s what you need to know.
Tennessee Opportunity Zones
In the state of Tennessee there are 176 census tracts that are qualified opportunity zones, and in Davidson County alone we have 18. These low-income tracts were nominated by Tennessee and certified by the Secretary of the Treasury. These 176 tracts in Tennessee were determined based on a strategic, data-driven information, county mayor feedback, and consideration of state priorities and initiatives including:
- Business development and brownfield redevelopment opportunities
- Retail, commercial and tourism development opportunities
- Community and rural development initiatives
- Low-income housing development opportunities
- Proximity to entrepreneur centers, technology transfer offices, and colleges and universities
Developing Opportunity Zones
If you look around Nashville right now you see development taking place pretty much everywhere, but the purpose of Opportunity Zones is not just to be developing for development’s sake. Instead, these QO Zones need development that is positive and improves the quality of life. Development that is accessible to all income levels and encourages walkability. One of the questions that kept being brought up during the lecture was ‘how are these QO Zones going to bring about growth and development for the existing community and not cause more gentrification issues?’ This is a very tough question to answer but Congress’ hope is that with these tax incentives, investors aren’t only concerned with the bottom line but with the current community’s success as well.
So, what are these tax incentives that I keep mentioning? There are three separate investment incentives that a taxpayer can elect to take advantage of with respect to their investment.
Temporary Deferral of Capital Gain
Under IRC Section 1400Z-2(a)(1)(A) the taxpayer can elect for temporarily defer capital gain from the sale or transfer to an unrelated party of any property that the taxpayer owns as long as the taxpayer reinvests the deferred amount in a qualified opportunity fund. The taxpayer must reinvest the deferred amount within 180 days. Gain deferral is only temporary and must be recognized the tax year the investment is sold or December 31, 2026, whichever is earlier.
Where a taxpayer has elected temporary gain deferral, IRC Section 1400Z-2(b)(2)(B) provides a tiered “step-up” in taxpayer’s basis gain it reinvests in the QO Fund, depending on how long the investment is held. If the investment is held for at least 5 years, the taxpayer’s investment is increased by 10% of the amount of capital gain that the taxpayer elected to defer. If the taxpayer decides to hold on to the investment for another 2 years (total of 7 years), the taxpayer’s basis is increased by an additional 5% (15% total) of the deferred gain. Now, here’s the catch, in order to obtain the full benefit of the basis step-up provision, the taxpayer will need to reinvest their capital gains in a QO Fund and elect deferral treatment by December 31, 2019.
Permanent Exclusion of Gain on Appreciation
Under IRC Section 1400Z-2(a)(1)(C) the taxpayer can elect an additional basis “step-up” that permanently excludes capital gain on the sale or transfer of the investment once it is held for 10 years. At this point, the taxpayer’s basis in the investment is equal to the fair market value of the investment on the date the investment is sold.
Types of Investments
The most popular type of investment in QO Zones is Real Estate, focusing on development and rehab projects. This is because it’s quite a bit easier and fairly straight-forward, however, this is not the only investment type in Opportunity Zones. Three other types are: new businesses created in QO Zones, expansion of businesses already in QO Zones, and outside businesses expanding into QO Zones. Wanting to learn more about Opportunity Zones? Thinking of investing in Opportunity Zones? Reach out to us!
Check to see if an address falls in an opportunity zone: https://www.cims.cdfifund.gov/preparation/?config=config_nmtc.xml
Tennessee Department of Economic and Community Development Opportunity Zone Page:
Economic Innovation Group, a bipartisan research and advocacy organization that helped plan the initial legislation that formed the basis for the QO Zones incentives: