In the United States, investors are offered tax benefits for investing in real estate within poor areas, known as Opportunity Zones. There are over 8700 Qualified Opportunity Zones (QOZs) available country wide. So, how do you take advantage of this program?
As a commercial real estate investor, you gain tax benefits for acquiring property in Qualified Opportunity Zones. You’ll need to invest via an Opportunity Fund, reinvest within 180 days of subsequent asset sales, renovate within 30 days, and 90% of the fund’s assets must be within a QOZ.
Opportunity Zones within real estate can be tricky to understand at first, but once you’re clued up, you can decide whether investing in this program is worth the reward. We’ll cover the definitions, potential investment opportunities, and the pros and cons.
What Does Opportunity Zone Mean In Commercial Real Estate?
A Qualified Opportunity Zone (QOZ) refers to a designated geographic area within the US Opportunity Zone program, known as census tracts.
As of December 22, 2017, these zones were governed by the Tax Cuts and Jobs Act. These properties have been designated by a governor and approved by the US Department of the Treasury based on a 20% poverty rate, below 80% median income, and low employment rates.
The government rewards your investments within these QOZs with tax benefits when you follow certain conditions as a reward for developing the area. The tax incentives can include the following:
- Investors can prevent paying capital gain taxes by reinvesting those gained by assets in Opportunity Zone investments.
- If your investment is held for at least five years, you may be eligible for a 10% reduction in capital gains tax on your original investment. For seven to ten years, you can reduce 15%.
- If you meet certain conditions and invest for at least ten years, you can enjoy 100% tax-free appreciation.
Eligible real estate can include office buildings, retail centers, industrial facilities, multifamily housing, and more. These investments can include new developments, renovations, or projects. You must invest through the Opportunity Fund to succeed in these tax incentives.
What Is The Opportunity Fund?
This fund is a dedicated investment vehicle that facilitates investments within QOZs.
You’ll need to reinvest capital gains in Opportunity Fund within 180 days of asset sales. You must also reinvest at least 90% of the fund’s holdings in eligible property or businesses within Opportunity Zones. Reinvestments can include new developments, renovations, improvements, and more.
If you follow the conditions, this fund defers your capital gains taxes until you sell the investment on December 31, 2026. You can structure the fund as a corporation or partnership, including Limited Liability Companies and qualified Real Estate Investment Trusts (REITs).
Note that ‘sin’ businesses like gambling, liquor stores, massage parlors, etc., do not qualify for the Opportunity Fund and may not own shares. However, you can still lease property to these prohibited businesses.
Types of Eligible Commercial Real Estate For Opportunity Zone Investment
Before you invest in Opportunity Zone real estate, it’s best to know the limits. Luckily, there are numerous types of QOZs at your disposal.
While the numerous types of eligible commercial real estate, investors and developers must follow the specific regulations and requirements outlined in the Opportunity Zone program to benefit from the associated tax benefits. Consult with your tax and legal professional or find one experienced in Opportunity Zones so that you can understand the complexities and maximize profits.
Your investment options include the following:
- Multifamily, Affordable, and Student Housing: You can develop or renovate residential buildings, such as apartment complexes. This is the focus of this program and the most popular investment.
- Office Buildings: You can construct or renovate new office buildings, which is especially useful for job creation.
- Retail Centers: Developing shopping centers, retail centers, or other commercial retail spaces attracts businesses and consumers to the community.
- Industrial Facilities: This includes manufacturing, distribution, and warehousing facilities that help with economic development.
- Hospitality and Hotels: Hotels, resorts, and hospitality properties attract tourists and business travelers to the area.
- Mixed-Use Developments: Projects that combine commercial, residential, and retail spaces can create functional communities and are great for profitability.
- Healthcare Facilities: This can include building or upgrading healthcare facilities, such as hospitals, clinics, or medical offices.
- Restaurants and Entertainment: Establishing restaurants, theaters, and entertainment venues spaces can contribute to the local economy and build on profit.
- Infrastructure and Public Amenities: Some project investments can include infrastructure improvements, such as roads, bridges, and parks, but it isn’t the most profitable.
Advantages And Disadvantages Of Opportunity Zones In Real Estate
Before your next venture, there are two sides to the Opportunity Zone coin that can make or break your success in the investment. Although tax benefits sound glamorous, it is only sometimes worth it, especially considering the 90% minimum reinvestment in QOZs.
The advantages of Opportunity Zones include:
- The potential for significant tax benefits includes deferral, reduction, and eventual exclusion of capital gains.
- Develops economically troubled areas, which helps many lives in job creation and community upliftment.
- It offers flexible real estate projects, including residential, commercial, industrial, and infrastructure opportunities.
- You’re able to invest as a corporation or partnership, including LLCs and REITs
- It can diversify your investment portfolio.
- In some instances, investments in Opportunity Zones can generate worthwhile returns, especially if the area experiences significant economic growth or property value increases.
- This program can potentially appreciate QOZs significantly, offering a promising return on investment.
- Investors who hold their Opportunity Zone investments for at least ten years can benefit from eliminating capital gains tax.
The disadvantages of Opportunity Zones include:
- Investments in Opportunity Zones carry risks, often involving economically distressed areas with unstable market conditions.
- It can be expensive, complex, and tedious to qualify for tax benefits, as you must meet strict compliance requirements that often require professional assistance.
- Investors have 180 days to reinvest capital gains, which creates stress in finding appropriate investment opportunities.
- You can get penalties or lose the tax benefits if you don’t meet the 90% asset test or other requirements.
- Not all Opportunity Zone investments will generate positive returns.
- Real estate markets within Opportunity Zones can vary in property value, demand, and competition.
Conclusion
The basics of what you need to know about Opportunity Zones in commercial real estate are that the tax benefits are promising, but there’s a lot that goes into making the investment meet the requirements. QOZs have plenty of potential to make a decent return on investment but are equally risky due to being economically distressed.