January 21, 2019
Opportunity zones have been getting quite a bit of buzz lately surrounding the full extent of their potential benefits and their possible applications. The tax breaks that can be attained from an investment could be substantial depending on the amount of unrealized capital gains that currently lies in your portfolio. The new zone locations as well as regulations to qualify are still being worked out in some areas, but there is a solid foundation built beneath it.
The zones are meant to free up investor’s capital gains over many years that are trapped in their portfolio. The new legislation’s goal is to move capital from investment accounts into impoverished areas in the US for real estate and venture development. The way it works is this: capital gains rolled over from other investments (stocks, real estate, private equity etc.) that is put into a Qualified Opportunity Fund (QOF) and held for a period of at least 5 years will receive a 10% exclusion of the deferred gain, if it is held for 7 years it moves up to 15%, if held for at least 10 years then funds are not subject to any capital gains tax and the investor receives a step-up in their cost-basis.
Opportunity funds are subject to several stipulations, and, some of which are still currently too vague and open to interpretation. For instance, the investment must show “substantial improvement” in the zone and if it is a business venture must make a certain amount of income within the zone. The exact qualifications necessary for “substantial improvement” is not clearly outlined yet and raises questions about how subjective or quantifiable that will become. Generating a certain amount of income within zones also poses questions about services that are off-site, but the physical business is located within the zone. A landscaping business could present one such gray area. Consider if it assists neighborhoods within the zone, but also services higher-income areas surrounding it as well, outside of the zone. Does this still qualify, or will it need to shift more of its business inside of the zone? The more that these funds are open to interpretation the more potential there is for them to be taken advantage of and the original purpose of the funds begin to erode.
Looking towards the future, Opportunity Funds have a great potential for a large amount of good to be created within the designated zones. The incentives are in place to attract significant investment and help jumpstart economic growth in these areas. We just need more information to establish clarity on the regulations that will ensure the capital is properly aligned with its intended purpose.
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