Q: What are Opportunity Zones?
A: Opportunity Zones are economically-distressed communities, designated by states and territories and certified by the U.S. Treasury Department, in which certain types of investments may be eligible for preferential tax treatment. The tax incentive is designed to spur economic development and job creation in distressed communities by providing these tax benefits to investors. Effective June 14, 2018, Treasury certified Opportunity Zones of all states, territories and the District of Columbia. Opportunity Zone designations certified by Treasury will remain in effect until December 31, 2028.
Opportunity Funds and Businesses
Q: What is an Opportunity Fund?
A: A Qualified Opportunity Fund is any investment vehicle organized as a corporation or partnership with the specific purpose of investing in Opportunity Zone assets. The fund must hold at least 90% of its assets in qualifying Opportunity Zones property.
Q: Who can create an Opportunity Fund?
A: Any taxpaying individual or entity can create an Opportunity Fund, through a self-certification process. A form (expected to be released in the summer of 2018) is submitted with the taxpayer’s federal income tax return for the taxable year.
Q: What can Opportunity Funds invest in?
A: Opportunity Funds can invest in any Qualified Opportunity Zone property, including stocks, partnership interest or business property (so long as property use commences with the fund, or if the fund makes significant improvements to the qualifying property).
Q: Will Opportunity Zone businesses need to conduct most of their business within Opportunity Zone tracts, or will it be sufficient if the majority of the business’ assets are located in Opportunity Zone tracts (property, equipment, etc.)? For example, would a trucking business based in an Opportunity Zone, but serving a whole region, qualify for Opportunity Fund financing?
A: To qualify as an eligible Opportunity Zone Business, a business must demonstrate that substantially all its tangible business property is located within a Qualified Opportunity Zone. No such stipulations have been made regarding the service area of the Opportunity Zone Business in the statute, but this may nonetheless be an item that the IRS chooses to address in future guidance or regulations.
Q: What happens if a business located in an OZ moves? Is there a recapture risk?
A: There is no recapture risk, but an opportunity fund that fails to meet the 90% asset requirement of the fund will be required to pay a penalty for each month it fails to meet the requirement. The penalty is not designed to be catastrophic, but rather, to ensure that funds stay within the zone’s parameters. Once an asset no longer qualifies, there will be a period of time in which the asset can be disposed of before incurring penalties.
Q: Can an Opportunity Fund make investments in multiple Opportunity Zones?
A: Yes, so long as an Opportunity Fund has at least 90% of its assets in Qualified Opportunity Zone property, the fund may invest in as many qualified tracts as desired.
Q: Can an investor invest directly into an Opportunity Zone business to qualify for associated tax incentives?
A: No, an investor must invest in an Opportunity Zone business through a Qualified Opportunity Fund in order to qualify for associated tax incentives.
Q: What tax benefits are available for investors that invest into an Opportunity Fund?
A: There are primarily three benefits available to investors that invest previously realized capital gains into an Opportunity Fund, with increasing benefits the longer the investment is held in the Fund:
- Deferral of capital gains taxes. An investor that re-invests capital gains (within six months of realizing the gains) into an Opportunity Fund can defer paying federal taxes on those realized gains until as late as December 31, 2026.
- Reduction of capital gains taxes. Investors that hold the investment in the Opportunity Fund for at least five years can reduce their tax bill on the deferred capital gains by 10%. This reduction increases to 15% for investors that hold the investments in the Opportunity Fund for at least seven years.
- Elimination of taxes on future gains. Investors that hold the investment in the Opportunity Fund for at least ten years will not be required to pay federal capital gains taxes on any gains realized from the investment in the Opportunity Fund.
Q: Can Opportunity Zones tax incentives be realized beyond 2026?
A: The tax incentive itself does not expire in 2026. Investors in Opportunity Funds that hold investments for at least 10 years will still be able to take advantage of the favorable tax treatment of gains related to the investments into Opportunity Funds, even if realized after 2026.
Q: Are there minimum or maximum investments?
A: There are no minimum or maximum investments required by Opportunity Zone legislation.
Q: What kind of returns are investors likely to expect?
A: We anticipate a broad range of investor return expectations. On one end of the spectrum, Opportunity Funds may raise capital from socially responsible, high net worth investors that would otherwise be contributing to donor-advised funds with a principal preservation focus and a low return expectation (e.g., less than 5%). On the other end of the spectrum are private equity fund investors that are expecting double-digit returns based on the risk of providing equity capital to real estate or business investments. In the middle are preferred equity investment models with 6-10% annualized return expectations.
Q: Once an Opportunity Fund is established, is there a timeframe within which investments must be made?
A: This timeframe will be determined in the IRS rule making process. Based on the legislation, an Opportunity Fund may need to have 90% of its capital invested in Opportunity Zone Property within the first six months of the taxable year of the Opportunity Fund. There may be some timing relief in the rule making to enable a 12-month investment window. Also, to receive the tax benefits, the investor must deploy their capital into an Opportunity Fund within six months of realizing the capital gain being invested.
Q: Do you anticipate the creation of single-use or single-purpose funds? For example, could a developer that does business in an Opportunity Zone create an Opportunity Fund for a specific project?
A: Yes, given the expected ease of certifying an Opportunity Fund and the timing constraints of investing the capital in Opportunity Zone Property, we anticipate that single-asset funds will be utilized.
Q: Will Opportunity Zones be compatible with LIHTC and NMTC investments?
A: As of today, we think Opportunity Zone investments could be combined with the Low Income Housing Tax Credit and New Markets Tax Credit, though we won’t know for sure until the Treasury Department releases its guidance.