The newly created “Opportunity Zones” are creating a lot of buzz in the real estate and business communities. Typically, when an investor divests an appreciated real estate investment, capital gains tax is due on the appreciated value. But if this property is in an Opportunity Zone, the appreciation is 100% tax-free if the investment is held for at least 10 years.
How did this get started?
Opportunity Zones were created through the federal Tax Cuts and Jobs Act in 2017 and rolled out in 2018. The purpose was to incentivize people to invest in economically distressed communities through capital gains tax incentives. Many people have the misconception that Opportunity Zones must be in an area of town you don’t visit after dark. Some are, but many are not. Some of the Opportunity Zones are located in suburban, industrial, downtown, and rural areas. Opportunity Zone designations are nominated by the chief executive of each state, then certified by the U.S. Treasury secretary.
Much of downtown Detroit is an Opportunity Zone, and this caught the eye of Quicken Loans founder Dan Gilbert, who went on a buying spree. Have you stayed in a cabin in Broken Bow, Oklahoma? You have stayed in an Opportunity Zone. Broken Bow is a great example of what being designated an Opportunity Zone can do for the local economy and real estate market. Many people are building houses and cabins in Broken Bow for rental income.
How it works
Anyone can invest in an Opportunity Zone. Investors create a Qualified Opportunity Fund. The QOF invests at least 90% of its assets into property or businesses within an Opportunity Zone. The process of investing in a QOF is surprisingly simple and can be accomplished in just days, with minimal costs.
What you can invest in
Multifamily housing, hospitality, self-storage, industrial, office, mining facilities, solar, retail and more
Benefits of Opportunity Zones
1. Deferral of capital gains
2. Reduction of deferred gain over time
3. Permanent gain exclusion on appreciation of investment
Deferral of capital gains
If you have a capital gain from a sale of a business, building, or stock, you can defer paying your capital gains tax by investing in an Opportunity Zone. You can defer paying the capital gain until the investment is sold or Dec. 31, 2026, whichever comes earlier. If the investment is not sold before Dec. 31, 2026, any remaining deferred gain is recognized at that time. To qualify for this deferral, you must invest some or all of the capital gain in a QOF within 180 days of the sale.
Reduction of deferred gain over time
Investments held for less than five years do not receive any reduction and must recognize 100% of their deferred capital gain. But if you hold the investment in the Opportunity Zone for at least five years prior to Dec. 31, 2026, you only have to recognize 90% of the deferred capital gain. Investments in Opportunity Zones prior to 2020 could qualify to receive a 15% exclusion if held for seven years.
Permanent gain exclusion on appreciation of investment
This is the most attractive part of Opportunity Zones. Investments held for at least 10 years receive a 100% permanent tax exclusion on the appreciation of the property. At the sale of the investment, an election is made to receive a stepped-up basis in the investment to fair market value. For example, if a person buys a building in an Opportunity Zone for $1 million, holds it for 10 years, and sells it for $3 million, the $2 million gain is tax-free. They pay zero capital gains tax. Typically, that gain would result in a capital gain tax bill of up to $400,000.
Ken Huffman is a CPA and founder of CPA to CPA, Inc. and Captive Nation, Inc., a captive insurance management firm in Fort Worth. He is writing this column on behalf of the Fort Worth CPAs, a regular contributor to Fort Worth Inc. Contact: [email protected] or 888-944-5588.