Opportunity Funds + Real Estate: A Match Made in Heaven

EQUITYMULTIPLE Team  |

In December of 2017, The Tax Cuts and Jobs Act was passed by Congress. A companion bill called the Investing in Opportunity Act quietly accompanied the broader tax bill, shepherded through with bipartisan support and the backing of community-minded stakeholders from the private sector. The objective: create substantial federal tax incentives for private-sector investment in select under-invested communities across the country called Opportunity Zones.

The bill is intended to stimulate investment in businesses, infrastructure, community resources, and real estate in historically underinvested communities. The program is intended in part to address the uneven distribution of wealth and economic vibrance across the country with a new approach: using massive tax incentives to stimulate private investment. U.S. investors currently hold an estimated $6.1 trillion in unrealized capital gains, representing a significant untapped resource for economic development.

To incentivize investors to redeploy those gains, the programs offers three core tax benefits:

  1. DEFER - Investors can roll capital gains from the sale of another investment into an Opportunity Fund and defer paying taxes until December 31, 2026.
  2. REDUCE TAXES OWED ON DEFERRED GAINS - If held for at least 7 years, the capital gains tax (on the deferred amount) owed by the investor on December 31, 2026 will be reduced by 15%.
  3. ELIMINATE - If held for at least 10 years, investors will pay no federal capital gains tax on the appreciation of their Opportunity Fund investment

Where and What Are Qualified Opportunity Zones

There are 8,700 qualified Opportunity Zones across the country that were nominated by U.S. Governors and ratified by the Treasury Department. The baseline qualified: at least 20% of the population living below the poverty line and/or average income in the area no better than 80% of area median income. Those many of these areas are undoubtedly under-resourced, this hardly means that they lack investment potential; many of these 8,700 designated areas possess strong public assets already, benefit from proximity to real estate demand drivers and, in some cases, are already exhibiting strong demographic trends.

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What is an Opportunity Fund?

  • Opportunity Funds are the investment vehicle created to invest in Opportunity Zones and must meet certain qualifications laid out in the statute and, soon, by the IRS.
  • An Opportunity Fund must hold at least 90% ofits assets in Qualified Opportunity Zone businesses and/or business property (including real estate).
  • Real estate focused Opportunity Funds must focus on new development or make substantial investment in renovating existing properties

Details of how much investors can expect to gain on post-tax returns can be found at our Opportunity Funds Resource Page. In short, though, these gains are potentially very, very robust: an Opportunity Fund held for 10 years may more than double the take-home return.


Why Real Estate is a Natural Fit for Opportunity Funds

The Opportunity Fund program offers strong tax incentives for localized real estate development (many would argue the most compelling in history). However, tax incentives for real estate development are not new; the New Market Tax Credit program and various HUD initiatives over the years have conditioned real estate investors to consider possible tax advantages. Moreover, real estate investors typically drive value through a combination of construction or renovation and long-term appreciation. It is common for real estate investment firms to hold properties 5-7 years (or substantially longer), and so this program dovetails with the longer-dated investments that can take full advantage of the tax incentives under the Investing in Opportunity Act.

In many of the qualified Opportunity Zones across the country, housing affordability remains a key challenge and an impediment to the economic wellbeing of the community. So creating workforce and affordable density housing in urban cores should be a major focus of this initiative.

Further IRS & Treasury Department Guidelines on Opportunity Funds

On Friday October 19th, the IRS released a first set of clarifying guidelines on Opportunity Funds and qualified Opportunity Zones. While some investors are still waiting on other key details, this latest round of rules did provide some much-needed clarity on the program.

These were the main takeaways from the proposed rules, in our view:

  • Substantial Improvement and Treatment of Land: Real estate investors who plan on rehabbing existing properties must make capital improvements costing at least as much as the underlying property within 30 months of acquisition if the investment is to qualify as an Opportunity Fund. However, per the new rules, the value of the land does not need to be included in this calculation. This makes it much more feasible for value-add projects to be included in Opportunity Funds
  • Required Proportion of Holdings within Qualified Opportunity Zone: Only 70% of an Opportunity Fund's tangible assets need be within a qualified opportunity zone in order to qualify. The original rules stipulated that 90% of a Fund's assets needed to be held within a qualified opportunity zone. So, applying the new 70-30 regulation to the remaining 90% means that as little as 63% of a fund could be invested inside an Opportunity Zone.
  • Use of Debt: Debt can be part of the financing of a qualified Opportunity Fund. In other words, a loan made toward an Opportunity Fund does not constitute a separate investment. This is a huge win for aspiring Opportunity Fund real estate investors who plan on leveraging debt.

The Bottom Line

The Opportunity Fund program may turn out to be one of the biggest drivers of real estate investment over the next 10-20 years, and provide investors a true opportunity to "do well by doing good".

Because of the unique flexibility of the program, individual investors can take advantage to a much greater extent than with previous tax incentive programs. As opposed to a 1031 exchange, non-real-estate investments can be rolled into qualifying Opportunity Funds, and at a much lower barrier to entry. At EquityMultiple, we plan on offering Opportunity Fund investments across the country, and at relatively low minimums.


DISCLOSURE: EquityMultiple plans to offer Opportunity Funds


The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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