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Tax-Advantaged Opportunity Zone Funds Are Coming to Market

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Advisors who have clients with capital gains, a long time horizon and a desire to make a socially responsible investment may want to consider opportunity zone funds.

The U.S. Treasury and IRS recently issued a first set of guidelines for these investments which allow capital gains to be deferred until the investment in the fund is sold or until Dec. 31, 2026, when the tax provision sunsets, so long as the capital gains are invested within 180 days.

The investment will also receive a stepped-up basis if it’s held for five years or longer, according to the following schedule: a 10% increase in basis at five years, 15% at seven years and market price at time of sale at 10 years.

(Related: How to Reduce Clients’ Taxes While Providing a Social Good)

In order to qualify for these benefits, an opportunity zone fund must invest at least 90% of its assets in a business located in one of 8,700 census tracts identified as opportunity zones by the federal government, based on selections by state governors of high-need communities. The business, in turn, must retain 70% of its tangible property in the opportunity zone. As a result, a fund is only required to have 63% of its assets invested in an opportunity zone.

“The bar is pretty low,” said Justina Lai, director of impact investing at Wetherby Asset Management, an RIA with offices in San Francisco and New York, about the impact requirement for opportunity funds.

Lai has been receiving pitches from opportunity zone funds that are starting up, primarily real estate deals, although there is no requirement in the legislation or guidelines restricting investments to that category.

She’s looking at these funds’ impact and investment strategies and how they can potentially benefit low-income people. “The impact investing industry will pay close attention.”

Andrew Hart of Delegate Advisors, also in San Francisco, says opportunity zone funds can attract investors who are sitting on gains of highly appreciated stocks, like tech stocks, and want the ability to defer taxes on those gains.

These investments are “potentially great but they have to be a good investment to begin with,” says Hart. “If it happens to be in an opportunity zone, we would look to rebalance a client’s portfolio to generate gains and then invest in a fund … We focus first on the investment side, not the taxes.”

On the sell side are investment companies like North Coast Partners, which expects to be raising funds soon for its Detroit Opportunity Fund. Managing Partner Matt Temkin tells ThinkAdvisor the fund will invest in new construction as well as substantial improvement projects in Detroit real estate. His firm has been talking to family offices, RIAs and high-net-worth individuals themselves, including individuals who have sold their company and have a big capital gain.

(Related: New Tax Bill Offers Attractive Impact Investment Opportunity)

“The feedback has been very positive,” says Temkin, noting that the firm has a “serious pipeline of a couple of hundred million dollars. “This will be huge. It can do great things for the country, moving capital into low-income communities.”

Temkin is pleased with the proposed government guidance, which notes that taxpayers can rely on the proposed regulations despite their draft status. Among other things, the guidance allows opportunity zone funds to collect money and hold the cash as working capital for 31 months as they develop their projects. “It’s clear they are trying to make the program work,” Temkin says.

Private equity investor Avy Stein, co-founder of Cresset Capital Management, which has teamed up with Diversified Real Estate Capital to launch a opportunity zone fund, hopes to raise $500 million and have a first closing by the end of this year. With a “very significant tax deferral at the beginning, tax reduction in the middle and tax elimination at the end if you hold the investment for 10 years.” This is “a very big deal,” says Stein.


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