As part of the 2017 Tax Cuts and Jobs Act congress created tax advantaged Opportunity Zone investments in order to encourage investment in economically distressed communities. Basic information on how this program works is readily available but if you want to get down to specifics – e.g. what kind of Chicago real estate investments would qualify – then you have to do a lot more digging because most of the discussion around this topic just covers the basics.
Here is what I was able to determine about the 3 main dimensions of the program. Some of this information is covered on the IRS’ Opportunity Zones Frequently Asked Questions page. However, if you are seriously considering taking advantage of this program you would be well advised to talk to an accountant rather than simply trusting my research.
The tax benefits of the program are pretty straight forward. If you sell an investment at a profit (capital gain) and reinvest the proceeds in this program you can defer paying taxes on that capital gain.
- You will pay taxes on that gain when you sell your Opportunity Zone investment but no later than December 31, 2026.
- If you keep your Opportunity Zone investment for at least 5 years you will be able to exclude 10% of the capital gain. Keep it for at least 7 years and you will get a 15% exclusion.
- If you keep your Opportunity Zone investment for at least 10 years you will not pay taxes on the gain from your Opportunity Zone investment. Just to be clear…this gain is separate from your original capital gain on which you are trying to defer paying taxes.
BTW, I assume that you can use this program to defer the capital gain on the sale of a real estate investment property instead of having to do a 1031 exchange. But again, ask an accountant.
Where The Opportunity Zones Are
The Opportunity Zones are generally low income census tracts, nominated by the states and later certified by the IRS. A state can nominate up to 25% of their low income census tracts. There is an interactive map of Opportunity Zones for the entire US. There is also an interactive map of the 133 Chicago Opportunity Zones. However, it’s not entirely clear if all 133 of these were ultimately certified by the IRS.
This is where it gets a little complicated and it’s hard to find detailed information out there. As far as I can tell investments need to be made through qualified opportunity funds (QOFs), which are corporations or partnerships that invest at least 90% of their assets in qualified opportunity zone property.
But what exactly is qualified opportunity zone property? Well, I finally stumbled upon the draft IRS instructions for filing form 8996, which is the form QOFs have to file annually in order to demonstrate that they meet the standards of the program. This is probably the most reliable source out there for what exactly qualifies as qualified opportunity zone property, though it is written with lots of typical IRS jargon that is defined in terms of other IRS jargon. From these instructions it appears that QOFs can invest in
- Qualified opportunity zone business property
- Stock in a qualified opportunity zone business
- A partnership interest in a qualified opportunity zone business
The instructions define opportunity zone business property as property that the QOF puts into service itself or substantially improves and that, during most of the holding period, was used mostly inside the qualified opportunity zone. The property will be considered substantially improved if the QOF makes improvements during any 30 month period that at least double the tax basis from the start of the 30 day period – i.e. you can’t just buy an existing property and pocket its existing income. There is actually an IRS revenue ruling out there that goes into a lot more detail on what exactly constitutes a substantial improvement for these purposes.
The instructions go on to define a qualified opportunity zone business as a business where substantially all of its owned or leased tangible property is qualified opportunity zone business property and all of the following are also true:
- At least 50% of its total gross income should come from a qualifying trade or business. Of course, I don’t see qualifying trade or business defined anywhere.
- The business uses a substantial part of its intangible property in this business
- Less than 5% of the average unadjusted basis of the property of the business is from nonqualified financial property, which they list as the typical financial instruments. This list actually raises some questions for me that I won’t go into here.
- The business is not a private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises. Hmmm. Maybe I lead a sheltered life but I’ve never heard of a hot tub facility but apparently it’s in the same league with massage parlors, liquor stores, and gambling facilities.
Most of what is written out there assumes that individual investors will make their investments through large QOFs that someone else has set up. However, in principle there is nothing preventing individuals from creating their own QOF by forming a corporation or partnership that complies with the dizzying requirements and then filing that form 8996 every year. So Chicago real estate investors should be able to buy real estate investment property in these Opportunity Zones and reap some tax benefits – as long as they structure them properly and improve them after purchase.
The Logical Outcome Of This Program
I would imagine that there will be some success with stimulating investment in these targeted communities. Tax incentives have a way of doing that. But I think that if they succeed in that regard it’s only logical to expect that the affected communities will end up complaining.
Why will they complain? Because property values will rise, property taxes will increase, and higher income people will start to move into the neighborhood. Yeah, the G word. And that’s how things work.
Gary Lucido is the President of Lucid Realty, the Chicago area’s full service real estate brokerage that offers home buyer rebates and discount commissions. If you want to keep up to date on the Chicago real estate market, get an insider’s view of the seamy underbelly of the real estate industry, or you just think he’s the next Kurt Vonnegut you can Subscribe to Getting Real by Email using the form below. Please be sure to verify your email address when you receive the verification notice.