In early 2012, the Economic Development Administration began to invest in 30 areas across the country known as Opportunity Zones. The goal of these programs, authorized by the Tax Relief Extension Act of 2010 (extension act), is to help revitalize neighborhoods that have been in decline for at least a decade and provide job opportunities for low-income households.
If you’re interested in investing in opportunity zone real estate development, you’ll want to know what they are and why they matter.
What are Opportunity Zones?
The federal government defines opportunity Zones as low-income neighborhoods with high poverty rates and homeownership rates below the national average. Opportunity Zones are “economic development districts” created by Congress in 2000 as part of the Tax Relief and Health Act. The designation means there’s already a demand for affordable housing in these areas, so investors can potentially make money by investing in opportunity zone real estate development.
Tax Benefits of Opportunity Zones to Investors
Opportunity Zones are areas designated by the Internal Revenue Service (IRS) that offer investors a chance to invest in real estate development projects. The IRS created the Opportunity Zone tax designation in 2010 to spur investment and job creation in communities struck by the recent recession. The program offers incentives for investing in distressed areas of up to $500,000 per opportunity zone area. It is administered by the IRS and supported by an agency called the Treasury Department.
Theoretically, if you invest in an opportunity zone, there are three ways it can help you: You can defer paying taxes on your investment gains or reduce your capital gains taxes, or no taxes on long-term investment.
- Taxes on capital gains are deferred. Capital gains are generally taxed at 20 percent, but they can be deferred until realized. Under an Opportunity Zone designation, investors won’t pay taxes on any capital gains until they sell their investment or redeem it for cash.
- Taxes on capital gains are reduced. Investors who purchase Opportunity Zone investments will also receive a significant tax reduction for real estate development within their Opportunity Zone. When you buy an opportunity fund and hold it for at least one year before selling it back into the market, then any profits you make when selling it back into the market will be considered “long-term” gains and, therefore, eligible for lower tax rates than if they were treated as ordinary income.
- Another key feature of Opportunity Zones is that investors who buy property inside an Opportunity Zone or invest capital within one will see no taxes on their long-term capital gains realized concerning that investment. Investors can earn yields on their investments without paying any capital gains.
Why Opportunity zones matter
The program was created as part of the American Recovery and Reinvestment Act of 2009 (ARRA) but has since been expanded to include state-designated Opportunity Zones. Creating an Opportunity Zone is often touted as an economic development strategy for local governments because it provides a vehicle for them to attract outside investment into their communities and reap significant tax revenue from selling this new development property.
The idea behind Opportunity Zones is simple: If a community experiences low unemployment rates and increased property values, it should be able to attract outside investment into its area. However, although the concept is sound, there are several challenges associated with creating Opportunity Zones that can make them difficult to implement effectively. The first challenge relates directly to land acquisition costs.
