Top Five Things You Need to Know About Qualified Opportunity Zones
Opportunity Zones have been the focus of many headlines and investors are keen to understand the investment opportunity. Below we outline the top things you need to know.
1. What are Qualified Opportunity Zones?
Qualified Opportunity Zones were created by the 2017 Tax Cuts and Jobs Act to stimulate investment in low-income communities. They are designated census tracts that exist in all 50 states (as well as the entire island of Puerto Rico). A map of the designated Opportunity Zones can be found here: https://eig.org/opportunityzones.
2. What is a Qualified Opportunity Fund?
A Qualified Opportunity Fund is the investment vehicle through which an investment in a Qualified Opportunity Zone is made. You cannot directly invest in a Qualified Opportunity Zone. Investments must be made through a Qualified Opportunity Fund, which can be organized as a corporation or partnership. The Qualified Opportunity Fund will then make the investment in applicable Qualified Opportunity Zone investments.
3. If this was created by a tax bill then there must be tax benefits, right?
Of course there are! The tax bill created three main tax benefits for investors. In order to qualify for any of them, you must realize gains and re-invest that money in a Qualified Opportunity Fund within 180 days. However, the IRS has eased the 180-day rule due to the coronavirus and resulting market disruption. This means that gains realized from October 5, 2019 through the end of 2020 are eligible, as well as all 2019 K-1 partnership gains. After meeting that timeline, you are eligible to receive the three tax benefits. The first two tax benefits relate to the original realized gains. First, you can defer tax on that gain until December 31, 2026 (but then you must pay up). Second, up to 15% of that gain can be excluded from tax so you may only owe tax on the remaining 85% of the gain. Finally, the last (and perhaps greatest) benefit relates to your investment in the Qualified Opportunity Fund itself. If you hold that investment for 10 years, 100% of the gain from the Qualified Opportunity Zone investment is excluded from income tax. That’s right, an entirely tax-free gain!
4. What kind of investments are covered by this tax bill?
The answer to this question has two parts – the types of investments you can realize gains on and then the types of qualifying investments you can make with those gains. First, the gains that you reinvest in a fund can be any type of gain, not just real estate related gains. So if you’ve been holding highly-appreciated Apple stock, you can reinvest that gain in a Qualified Opportunity Fund and qualify for all the tax breaks just mentioned. Second, real estate investors and venture capitalists are both evaluating investment “opportunities” that are eligible for these tax benefits. Qualified Opportunity Zone investments can be made in a variety of tangible property as well as corporate stock and partnership interests of businesses operating in Qualified Opportunity Zones.
5. Great! Am I missing anything else?
Now the IRS has clarified remaining issues on some technical details, investment funds are raising capital for Qualified Opportunity Funds. However, a few additional details are worth highlighting. First, legal structures and entities of funds range from direct investments to open- and close-ended funds, to real estate investment trusts and beyond. Second, some states have conformed with the federal tax breaks and will offer state incentives while a handful of states will not be offering state tax breaks for Qualified Opportunity Fund investments. Third, a growing cohort of impact investors are evaluating investments in underserved opportunities, but as it currently stands, no provisions in the Act mandate impact reporting or investing responsibly. Given the breadth of the opportunity set, it is prudent to understand the tax implications and financial return potential of the investments. Don’t let the tax tail wag the dog!
To learn more, read our Primer on Opportunity Zones.
If you have further questions, don’t hesitate to contact your Relationship Team.
Glenmede’s Top 5 is intended to be an unconstrained review of matters of possible interest to Glenmede Trust Company clients and friends and is not intended as personalized investment, estate planning, tax or legal advice. Investment and wealth advice depends on many individual facts and circumstances we cannot account for here. For legal and tax advice, consult your lawyer or accountant. Opinions or projections herein are based on information available at the time of publication and may change thereafter. Information gathered from other sources is assumed to be reliable, but accuracy is not guaranteed. Outcomes (including performance) may differ materially from expectations herein due to various risks and uncertainties. Any reference to risk management or risk control does not imply that risk can be eliminated. All investments have risk. Please contact your Glenmede representative to discuss the applicability of any matter discussed herein.