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OZ Investment Guide

What Investors Need to Know about Investing in Opportunity Zones?

The commercial real estate market has been in a bull market for several years now, but not all communities have benefited equally. In order to stimulate economic growth and development in lower-income areas, the federal government launched the “Opportunity Zone” program in 2017, with investments beginning shortly thereafter. It took several months for opportunity zone guidance to be issued (and then refined) by the Internal Revenue Service (IRS), but today’s investors find that investing the proceeds from the sale of certain assets into a qualified opportunity zone can be an excellent tool for deferring, reducing, and even totally excluding capital gains tax.

In this article, we look at why and how investors might invest in opportunity zones and then compare this investment vehicle to 1031 exchanges and Delaware Statutory Trusts (DSTs), two other tools that can be leveraged for realizing similar tax benefits.

What is a qualified opportunity zone?

A qualified opportunity zone, or QOZ, is an economically distressed community where new investments, under certain conditions, may be eligible for preferred tax treatment.

The QOZ program was created by the federal government in 2017 as part of the Tax Cuts and Jobs Act. The “Investing in Opportunity Act” legislation is defined in Internal Revenue Code Section 1400Z. Under this legislation, the governor of each U.S. state and territory was able to nominate up to 25 percent of their qualifying census tracts as QOZs.

To be eligible for nomination, the census tract must have had a poverty rate of at least 20 percent as of the 2010 census.

In total, more than 8,700 census tracts have been designated throughout the United States, District of Columbia, and U.S. territories.

Qualified Opportunity Funds

In order to invest in a QOZ, an investor must use a qualified opportunity zone fund, or QOF. A QOF is an investment vehicle organized as either a partnership or corporation and must hold at least 90 percent of its assets in QOZ property. An LLC may be a QOF if it chooses to be treated as either a partnership or corporation for federal income tax purposes and if it is organized for the purpose of investing in a QOZ property.

Per IRS guidelines, a QOF must double its basis within a 30-month period in order to qualify for the tax benefits and provide a “substantial improvement” to its assets.

QOF Tax Benefits

The primary reason investors are drawn to QOZs is for the potential tax benefits associated with investing in these areas. QOFs offer a unique opportunity for investors who plan to sell a range of investments, including, but not limited to, stocks, bonds, real estate, closely held business assets, cryptocurrency, jewelry, and art. When the gains realized from the sale of these assets are reinvested into QOFs, an investor can potentially benefit from the following “triple-layer” tax incentives:

  • Deferral: Those who rollover their capital gains into a QOF can defer capital gain recognition from the original investment until December 31, 2026.
  • Reduction: The amount of capital gain recognized from the original investment is reduced by 10 percent after achieving a five-year holding period, as long as that five-year holding period is achieved by December 31, 2026.
  • Exclusion: Long-term investors are eligible to pay no tax on the appreciation of their QOF investment upon disposition of that investment, regardless of the size of the profit, if the assets held in that QOF are held for at least 10 years.

QOFs vs. 1031 Exchanges

At first glance, it may seem as though the tax benefits associated with investing in a QOF are similar to those realized when reinvesting through a 1031 exchange. However, notable differences exist.

First, only proceeds from the sale of real estate can be rolled into a 1031 exchange. Capital gains from other assets, including stocks, bonds, and business equipment, can be reinvested into a QOF.

Second, QOF investors are not required to identify a replacement property within 45 days, nor must they use a qualified intermediary like they do with a 1031 exchange. Instead, investors are given 180 days to reinvest the proceeds from the sale of their prior assets into a QOF.

Third, to be eligible for a 1031 exchange, investors must invest the value of their original investment and the gains realized upon sale into another like-kind asset. When investing in a QOF, investors simply have to invest the gains—they can pocket their original investment.

One benefit to utilizing a 1031 exchange, however, is that gains can be reinvested in any geography. Investors are not limited to specific census tracts as they are when investing in QOFs.

QOFs vs. DSTs

Another popular way to defer paying capital gains tax on the sale of real estate is by reinvesting the proceeds into a Delaware Statutory Trust, or DST. DSTs are eligible for the same tax benefits as 1031 exchanges, which means investors can use DSTs as a vehicle for deferring capital gains tax, sometimes indefinitely.

Investors often use DSTs in conjunction with 1031 exchanges but as an alternative to “whole property” 1031 exchanges.

In short, investors can roll the proceeds of the sale of their property – in whole or in part – into a DST. The investor then holds proportionally fractional indirect ownership in the property (or properties) owned by the DST. One of the primary benefits of investing in DSTs is that DSTs are generally already established with a portfolio of properties identified, which allows investors to move faster than they would be able to if conducting due diligence on whole-property 1031 exchanges.

While both QOFs and DSTs offer significant tax benefits, there are differences between the two investment vehicles to consider.

  • Investments in QOFs are intended for ground-up and value-add investments. DSTs are better suited for non-speculative, stabilized, and cash flow-generating properties.
  • QOF capital gains deferred through 2026 are eligible for a partial step-up; they must be held for at least 10 years to be excluded. DST investments are not eligible for exclusion but may be deferred indefinitely. The asset basis is stepped up to fair market value at the time of the investor’s death.
  • Only capital gains from real property may be reinvested in a DST, whereas the short- and long-term gains on the sale of nearly all assets can be reinvested in a QOF.
  • QOF investments have strict geographic boundaries compared to DST investments, which can be made anywhere in the United States regardless of the census tract or local poverty rate.
  • DSTs are required to identify a property or portfolio of properties prior to accepting investments. QOFs are not subject to the same regulation. QOFs may have what is known as a “blind pool,” meaning that capital deployment is flexible as long as 90 percent of assets remain in a QOZ.

Which investment vehicle is right for you?

Qualified opportunity funds, 1031 exchanges, and Delaware Statutory Trusts all have their own pros and cons. Each is an equally effective method for realizing tax benefits. Often, these strategies can be used in conjunction with each other.

When determining which investment vehicle is best for you, consider the following:

  • How much authority do you want to have over how funds are invested? The usual “blind pool” nature of QOFs means that investors are often unaware of exactly how their capital will be invested. This is different from investing in a 1031 exchange or DST, where the assets have already been identified.
  • Is a step-up in basis important to your legacy planning? When investors pass away, any investment they have made in a QOF will not receive a step-up in basis to market value as it would if it had been invested in a DST. Therefore, heirs will be forced to pay the tax consequence upon selling ownership in the QOF.
  • Has the asset you are planning to sell already been depreciated? Unlike 1031 exchanges and DSTs, QOFs do not allow you to defer depreciation recapture on the underlying asset upon sale. Under current tax law, 1031 exchanges and DSTs allow you to perpetually defer depreciation recapture.
  • What is your risk tolerance? The purpose of creating QOZs is to spark economic development in economically distressed areas. This requires speculative development of ground-up (i.e., new construction) or heavy value-add projects. Opportunistic real estate deals such as these can be riskier than investing in a potentially stable, cash-flowing asset when investing through a DST. Those with a higher risk tolerance might be drawn to QOFs, whereas those with a lower risk tolerance might opt for investing in a DST instead.Of course, this discussion of risk is relative, as both of these products are considered high-risk investments.

If you are considering selling investment property, it is worth understanding the full suite of options available for maximizing the value of your proceeds. Contact us today. Our team would be happy to consult with you about which strategy might be best for your specific investment goals.

Opportunity Zone Disclosures

  • Opportunity Zones (“OZ”) are speculative.OZs are newly formed entities with no operating history. There’s no assurance of investment return, property appreciation, or profits. The ability to resell the fund’s underlying assets is not guaranteed. Investing in OZ funds may involve higher risk than investing in other established real estate offerings.
  • Long-term.OZ funds are illiquid and return of capital and realization of gains, if any, from an investment will generally occur only upon partial or complete disposition or refinancing of such investments.
  • Limited secondary market.Although secondary markets may provide a liquidity option in limited circumstances, the amount you will receive is typically reduced.
  • Difficult valuation assessment.The portfolio holdings in OZ funds may be difficult to value. As such, market prices for most of a fund’s holdings will not be readily available.
  • Default consequences.Meeting capital calls to provide pledged capital is a contractual obligation of each investor. Failure to meet this requirement in a timely manner could have adverse consequences including forfeiture of your interest in the fund.
  • Leverage.OZ funds may use leverage in connection with investments or participate in investments with highly leveraged structures. Leverage involves a high degree of risk and increases the exposure of the investments to factors such as rising interest rates, downturns in the economy, or deterioration in the condition of the assets underlying the investments.
  • Unregistered.The regulatory protections of the Investment Company Act of 1940 are not available with unregistered securities.
  • Regulation.It is possible, due to tax, regulatory, or investment decisions, that a fund, or its investors, are unable to realize any tax benefits. Evaluate the merits of the underlying investment and do not solely invest in an OZ fund for any potential tax advantage.

Perch Wealth provides you with access to institutional-quality real estate, management, financing and state of the art 1031 exchange processing.



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Real Estate / 1031 Risk Disclosure:
  • There’s no guarantee any strategy will be successful or achieve investment objectives;
  • All real estate investments have the potential to lose value during the life of the investments;
  • The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;
  • All financed real estate investments have potential for foreclosure;
  • These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments;
  • If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
  • Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits;
  • Tax benefits are not guaranteed and are subject to changes in the tax code.