Research

Legislation Creating Opportunity Zones Offers Significant Tax Benefits — an Overview

Recent federal tax legislation introduced "Opportunity Zones," a new community reinvestment tool designed to use tax incentives to drive long-term investment to rural and low-income urban communities throughout the nation. The Opportunity Zone program is the first new national community investment program in over 15 years and has the potential to be the largest economic development program in the U.S. This broad legislation will benefit many stakeholders from individual taxpayers to developers and fund sponsors.

Who can benefit?

  • Individuals or corporations looking to defer tax on capital gains
  • Real estate developers and start-up companies located in an Opportunity Zone who are seeking an equity investment for their development or business
  • Real estate sponsors, syndicators and/or private equity funds who are looking to create Opportunity Funds that will then invest in Opportunity Zone projects

What are the benefits?

A taxpayer who timely reinvests gain from a sale of property into a "Qualified Opportunity Fund" ("Fund") can enjoy the following tax benefits:

  1. Deferral: gain on the property sale is deferred until the earlier of the date that the taxpayer sells its interest in the Fund or December 31, 2026.
  2. Capital gain reduction: if the taxpayer invests in the Fund for at least 5 years, 10% of the original deferred gain is excluded from tax; if the taxpayer invests in the Fund for at least 7 years, an additional 5% (for a total of 15%) of the original deferred gain is excluded from tax.
  3. Appreciation exclusion: If the taxpayer invests in the Qualified Opportunity Fund for at least 10 years, all appreciation in the investment will be tax-free.

What is an Opportunity Zone?

Opportunity Zones are areas designated by the Governor of each State that are located in either a low income census tract or a census tract contiguous with a low income census tract. Governors are limited to designating up to 25% of their low income census tracts and up to 5% of the contiguous tracts as Opportunity Zones. Each Governor will submit such designation to the Treasury Department for certification. For those familiar with the New Markets Tax Credit program these are essentially the same census tracts.

The location of each Opportunity Zone may be a factor in deciding whether to make an investment in an Opportunity Fund.

What is an Opportunity Fund and applicable investment assets?

An Opportunity Fund can be either a corporation or partnership which was organised for the purpose of investing in an Opportunity Zone and that holds at least 90% of its assets in an Opportunity Zone property. Opportunity Funds will need to be "qualified" by the Treasury Department and guidelines on this process are expected to be released in the second quarter of 2018.

There are few limitations on what an Opportunity Fund can invest in, so long as the investment is made in an Opportunity Zone. As a result, an Opportunity Fund is able to invest in real estate projects (residential, commercial, or mixed use) located in Opportunity Zones or invest in a start-up business where substantially all of the assets of such business are used in the Opportunity Zone.

Examples of tax benefits from investing in an Opportunity Fund

The following examples illustrate the benefits of investing in an Opportunity Fund:

Investment in Fund is Held for 10 Years and Sold in 2028
Sullivan & Worcester Investment in Fund is Held for 10 Years and Sold in 2028

As a result of holding an investment in an Opportunity Fund for 10 years, and assuming the investment in the Opportunity Fund doubles over the 10 year period, a taxpayer would save $27.37 in tax, and would also enjoy the benefit of deferral of tax on the gain that is invested in the Opportunity Fund until 2026.

Investment in Fund is Held for 7 Years and Sold in 2025
Sullivan & Worcester Investment in Fund is Held for 7 Years and Sold in 2025

As a result of holding an investment in an Opportunity Fund for 7 years, a taxpayer would save $3.57 in tax, and would also enjoy the benefit of deferral of tax on the gain that is invested in the Opportunity Fund until 2025.

Investment in Fund is Held for 5 Years and Sold in 2023
Sullivan & Worcester Investment in Fund is Held for 5 Years and Sold in 2023

Conclusion

The Opportunity Zone legislation offers opportunities to become Opportunity Fund sponsors, incentives to entice investors looking to defer capital gains tax, and developers and start-up entities seeking capital to fund businesses operating in an Opportunity Zone.


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