What is a Qualified Opportunity Fund?
The Tax Cuts and Jobs Act of 2017 added many new tax provisions for 2018. One such provision created something called Qualified Opportunity Zones which are intended to spur economic development and job creation in designated distressed communities. People or entities that invest in eligible property located in an Opportunity Zone will receive certain tax benefits under the new law. Qualified Opportunity Funds are the investment vehicles set up through a partnership or corporation which allow groups of investors to take advantage of these tax benefits.
What Are the Benefits of Investing in an Opportunity Fund?
Investors who invest in a Qualified Opportunity Fund are eligible for several tax benefits. First, investors are able to defer tax on any prior gains so long as the gain is reinvested in a Qualified Opportunity Fund. Investors can defer such gain until their investment is sold/exchanged or December 31, 2026. Under the new law, investors have 180 days to reinvest their gains into an Opportunity Fund in order to take advantage of the tax deferral. For example, an investor sells some stock for gain in 2018. They have 180 days to reinvest some or all of that gain into a Qualified Opportunity Fund. If they invest all the gain into the Fund then they can defer paying taxes on the gain until they either resell/exchange their investment in the Fund or December 31, 2026, whichever occurs first. That’s potentially deferring taxes on capital gains for up to 8 years!
Second, investors who hold their investment in an Opportunity Fund for more than 5 years are eligible for certain increases to their basis. This has the effect of allowing investors to have a portion of their tax on their gain being forgiven. If the investment is held for 5 years the basis is increased by 10% resulting in only 90% of the gain being taxed; after 7 years the basis is increased by 15% resulting in only 85% of the gain being taxes. Finally, after 10 years investors can increase their basis to the fair market value of the investment on the date the investment is sold which effectively eliminates any additional gains on appreciation. Opportunity Funds provide a great way for investors to defer and reduce their capital gains taxes.
How Do I Get Approved as a Qualified Opportunity Fund?
According to the IRS, in order to become a Qualified Opportunity Fund, the taxpayer self certifies. That means there is no approval process or nor do you need to wait for any action by the IRS. The Fund just needs to complete a form and attach that form to the Fund’s tax return for the year.
There are of course a few other requirements for operating an Opportunity Fund. First, as mentioned above, the Fund has to invest in eligible property located in an Opportunity Zone. These zones are specifically designated areas that have been nominated by the state they are in and certified by the Secretary of the US Treasury. Opportunity Funds are required to hold at least 90% of their assets in Qualified Opportunity Zones. These assets can be in the form of corporate stock or partnership interest in a business located in a Qualified Opportunity Zone or tangible property located in a Qualified Opportunity Zone. The US Treasury maintains a current list and map of certified Qualified Opportunity Zones here: https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx
What does this mean for Syndicators?
Real estate syndicators can use this tax law as an additional selling point to potentially pull in new investors. In addition to the advantages of investing in real estate in general, investors in a syndication organized as a Qualified Opportunity Fund are eligible for the additional tax benefits discussed above. Once the self-certification form is released later this summer, syndicators would just need to identify suitable property located in a Qualified Opportunity Fund. As of this writing, the US Treasury has certified Qualified Opportunity Zones in all 50 states, so there is plenty of opportunity for syndicators to take advantage of the new tax law.