Real estate investors and developers have awaited guidance from the U.S. Treasury about Opportunity Zones established under last year’s tax overhaul. Some questions were answered on October 19, 2018 with the release of proposed rules. Taking this into account, CBRE has assembled this quick reference guide to answer the most frequently asked questions from our clients.
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How do Qualified Opportunity Zones impact the commercial real estate industry?
- Tax benefits that accompany Opportunity Zones (OZ) create a powerful incentive to allocate capital into economically distressed areas and in some cases, allow investors to defer taxes on realized gains and even reduce tax liability.
- If the OZ concept succeeds, its effects could be locally transformative for certain areas.
- More vibrant communities driving improved real estate fundamentals will create new investment opportunities.
- Time is of the essence for investors in order to fully take advantage of the program’s tax incentives.
- The US Department of Treasury recently issued additional guidelines, which helped clarify many issues, but not all. More guidance is expected around the end of the year. Even still, market participants can use current guidelines to move forward.
Why were Opportunity Zones created?
Opportunity Zones were created as part of the 2017 Tax Cuts and Jobs Act (a.k.a. tax reform). The idea behind these zones is to attract investment capital—specifically, capital gains—into “economically distressed” areas. In return for these investments, investors receive several tax benefits, which vary depending upon the time capital remains invested in a Qualified Opportunity Zone (QOZ).
What are the criteria to become a Qualified Opportunity Zone?
Recommendations for areas to be certified as QOZs were made by governors in each state.
What is a Qualified Opportunity Zone business?
- Opportunity fund can invest in an OZ business directly or through subsidiary.
- “Substantially all” tangible business assets must be used in an OZ (70%).
- Most businesses qualify (exceptions include golf courses, country clubs, gambling establishments, etc.).
What is a Qualified Opportunity Zone business property?
- Tangible property used in trade or business.
- Must be purchased after 2017.
- Original use of property must begin with certified OZ entity.
- Alternatively, if a certified entity (OZ fund or co.) “substantially improves.”
- Improvements equal to cost of building acquisition must be made within 30-month period.
What are the tax advantages of a Qualified Opportunity Zone?
Beyond the initial 180-day period in which funds must be reinvested, there are other timeframes that investors should take note of to fully benefit from tax advantages offered through the QOZs.
For example, a QOZ investment allows for the reduction of deferred gains from the sale or exchange of prior investments. QOZ investments maintained for at least five years by the end of 2026 will qualify for a 10% reduction of deferred capital gains tax liability (for the original capital gain). If the gain has been invested in an opportunity fund for seven years by the end of 2026, the tax liability on the original gain is reduced by 15%. Consequently, in order to take advantage of at least some of these benefits, capital gains must be reinvested by the end of 2021.
Beyond the five- and seven-year periods, gains from investments in QOZs become tax free after an investment period of at least 10 years (this does not include the original gain reinvested in the QOZ and will apply to assets held until 2047). As currently written, should Congress extend the 2026 due date for taxes on original gains to at least 2028, it could be possible to erase tax liability for all gains. However, it is worth emphasizing Congressional action would be required for the 2026 date to be extended.