Opportunity Zone Funds
HISTORY BEHIND OPPORTUNITY ZONES
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“TCJA”), the most extensive tax legislation since the Tax Reform Act of 1986, was signed into law by President Donald Trump. The TCJA includes many changes to tax brackets, including minor reductions to income tax rates, key changes in relation to taxation of foreign income, and significant reduction of the income tax rate for corporations. In addition to the sweeping general changes to the tax code, the TCJA created a new kind of real estate investment opportunity called Opportunity Zones.
According to the Internal Revenue Service (“IRS”), an Opportunity Zone is “an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.”
In essence, Opportunity Zones are areas within states that states designate as requiring more funding towards development and infrastructure. Because some states may not have funds to spur economic development and job creation within all of the necessary communities, by establishing the Opportunity Zones the federal government encourages private investment in designated low-income communities that require the most immediate assistance.
OPPORTUNITY ZONES IN NYC
There are currently 514 approved Opportunity Zones in NY State, with multiple Opportunity Zones in all 5 Boroughs. You can find the full list of the approved Opportunity Zones in NY State here: List of NY Opportunity Zones 2019
STRUCTURE OF AN OPPORTUNITY ZONE FUND
Opportunity Zones may only receive investment funds via a Qualified Opportunity Fund (“QOF”). QOFs are investment vehicles that are set up as either a partnership or corporation for investing in eligible properties that are located in Qualified Opportunity Zones. QOFs must be set up in the United States or its territories. In order to qualify as a QOF, the eligible corporation or partnership must hold at least ninety (90%) percent of its assets in qualified Opportunity Zone property as measured on the last day of the first six (6) month period of the taxable year of the fund, and, thereafter, on the last day of each taxable year of the fund.
Eligible corporations and partnerships will be able to choose the first month in which they are treated as a QOF. If a QOF does not meet the ninety (90%) percent requirement, and there is no reasonable cause for such failure, the QOF “shall pay a penalty for each month it fails to meet the requirement in an amount equal to the product of (A) the excess of the amount equal to ninety (90%) percent of its aggregate assets, over the aggregate amount of qualified opportunity zone property held by the fund, multiplied by (B) the underpayment rate established for such month.
BENEFITS OF OPPORTUNITY ZONE FUNDS
So what do Opportunity Zones mean for real estate investors? The federal government knew that private investors would have no reason to invest in economically distressed communities without prospective reward. Therefore, Opportunity Zones are a tool to incentivize private investors by providing major tax benefits to those that are willing to play the long game.
By structuring their investment through a Opportunity Zone Fund, investors can temporarily defer inclusion of taxable income for any capital gains that are reinvested in such fund until the earlier of the date the investment in such fund is sold or exchanged, or December 31, 2026. Further, if the investment is held for at least five (5) years, there is a 10% reduction of the deferred tax payment on the original capital gains, and if the investment is held for at least seven (7) years, there is a 15% reduction of the deferred tax payment on the original capital gains. Finally, if the investor holds an investment in an Opportunity Fund for at least ten (10) years, they will pay as little as zero taxes on any of the investment profit incurred.
DO I NEED AN ATTORNEY FOR AN OPPORTUNITY ZONE FUND?
Having legal and tax advisors who understand the regulations and compliance issues with respect to Opportunity Zone Funds is a prerequisite for success in this new area. If you plan to set up an Opportunity Zone Fund you will need an attorney who can help with:
- Structuring a Qualified Opportunity Fund;
- Preparation of fund documents in compliance with securities laws, rules, and regulations;
- Tax planning;
- Representation in the acquisition, development, operation and sale of properties in Opportunity Zones;
- On-going support and compliance advice.
In conclusion, Opportunity Zones offer creative investors many ways to reinvest their capital gains derived from other investments with the benefit of reaping very substantial tax benefits over time, while also further diversifying investors’ portfolios with real estate investments in the process.
Petro Avenue, Esq
Steven Bertoni, An Unlikely Group of Billionaires and Politicians Has Created the Most Unbelievable Tax Break Ever, Forbes (Jul. 18, 2018), https://www.forbes.com/sites/forbesdigitalcovers/2018/07/17/an-unlikely-group-of-billionaires-and-politicians-has-created-the-most-unbelievable-tax-break-ever/#79b4a914855c.
Disclosure: This is a law blog by an New York real estate attorney. This blog is for general informational purposes only and does not express or provide a legal opinion.