Top Five Things You Need to Know About Qualified Opportunity Zones
November 7, 2018
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 Congress in 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 federal tax benefits for investors. In order to qualify, you must realize capital gains and re-invest that money in a Qualified Opportunity Fund within 180 days. The first two tax benefits relate to the original realized gains. First, you can defer tax on that gain until December 31 2026 or the time you dispose of the Fund (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 if you meet certain holding period requirements. Finally, the last 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 may be excluded from federal income tax.
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. Only capital gains may be reinvested in a fund. So if you’ve been holding highly-appreciated Apple stock, you can reinvest that gain in a Qualified Opportunity Fund and qualify for the tax breaks just mentioned. The Funds themselves can make Qualified Opportunity Zone investments in 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 investment s 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 or email us at Top5@glenmede.com.
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