Part of the tax overhaul enacted in 2017 is a special provision called the Investing in Opportunity Act, which focuses on drawing private investments into distressed communities. By investing in Opportunity Zones, investors with unrealized gains will be able to defer, reduce or eliminate capital gains taxes. According to the Economic Innovation Group, there is at least $6 trillion in unrealized capital gains in the economy, creating a significant opportunity for investors to exit locked investment positions.
Types of Investments
More than 8,700 census tracts in the U.S. have been approved as Qualified Opportunity Zones (QOZs), low-income areas that lawmakers see benefiting from an inflow of private capital. Many individual investors have the capital, but not the ability to invest directly in these areas, but they can take advantage of an Opportunity Fund, a partnership or corporation that invests at least 90% of its assets in Opportunity Zone property. Capital gains tax on the initial investment is deferred until 2026 or the time at which the investor exits the QOF.
The program will also enable sophisticated investors to invest in property directly, in a manner similar to a 1031 exchange, with the additional incentives of a reduced deferred tax bill and a requirement that only capital gains be reinvested. Such QOZ property may consist of real assets or companies where a significant portion of property and revenue lies in, or derives from, a QOZ. Additionally, if the deferred gain is held in the fund for five years, the capital gains tax on this initial investment is reduced by 10%, a discount that increases to 15% after year 7. If the deferred gain is held in the fund for at least 10 years, any additional gain on this initial investment is tax-free, further incentivizing QOFs.
To ensure compliance, an asset test will be conducted twice a year to confirm that 90% of a fund’s assets are invested in Opportunity Zone property. This fact has led some to believe that funds must deploy new capital into Opportunity Zone property within 180 days, although further clarification is needed. Thus, the Investing in Opportunity Act creates the potential for investors to reap tax gains while positively impacting impoverished areas that stand to benefit from an influx of capital.
Impact and Outcome