By Debra Hazel
Let’s get one thing straight at the outset: If you’re investing in a new Qualified Opportunity Zone fund or business, you will owe taxes for 2026.
That may be the biggest misconception about these investments, which were created as a part of the Tax Cuts and Jobs Act of 2017 to encourage investment in underdeveloped communities. Investors can defer capital gains taxes from the sale of other investments (including property, stock, a business or other investments) for seven to 10 years by redeploying those gains (not the full sale proceeds) in an opportunity fund. Some 8,700 such zones have now been created nationwide. But it doesn’t eliminate taxes. The investment will defer taxes and reduce the amount paid depending on how long the investment is held. Any profit on the investment in the new fund is tax free if the investor remains in the fund for 10 years. But the initial gain invested in the fund will still be taxed by December 31, 2026.
“So many people I speak to are totally confused about taxability,” noted Marc Wieder, a partner and co-leader of the real estate practice at accounting firm Anchin, Block & Anchin LLP. “Come 2026, everyone is paying tax on the gain, between 85% and 100% of that gain.”
But some questions remained about what qualified for the program. In April, the U.S. Treasury issued more guidance about the zones which addressed many — but not all — of the issues surrounding investments. Investors now know that 70% of a property must be used in a qualified zone to be considered a qualified opportunity zone business. Tangible property must be qualified opportunity zone property for at least 90% of the fund’s or business’ holding period. And investors now know that funds will be allowed to sell a single asset in a fund, and investors who have been in that fund for 10 years can still exclude the gain.
The new opportunity could be an alternative to 1031 exchanges, which defer capital gains taxes on the sale of a property if the monies are reinvested into another property. However, in 1031 exchanges, both the principal and the capital gain must be reinvested within 180 days of a sale, and only real estate investments apply. With Opportunity Funds, the investor must reinvest the capital gains only (within 180 days of the gain being realized), and may invest in real estate or a qualified business.
“If you’ve always done 1031s, keep on doing it,” Wieder said.
Even so, more clarifications are needed, according to Wieder. Gains from a sale of an asset by a Qualified Opportunity Zone Fund can be excluded from income, if held for 10 years, but not for Qualified Opportunity Zone Businesses.
“If a qualified opportunity one fund makes a distribution of cash or property to an investor, it won’t trigger a gain if the investor has basis equal to or greater than the distribution,” Wieder said. “Basis is a big issue. Will I be allocated a share of liabilities in order to have that basis? Do I trigger a gain if I receive cash?”
About one-third of the Bronx is considered an Opportunity Zone, noted Jonathan Squires, senior director in the New York Middle Markets Investment Sales Group of Cushman & Wakefield, and much of it could qualify for Opportunity Funds, especially residential development sites in Mott Haven and industrial property in Hunts Point.
One such opportunity he worked on last year was at 1318 Oak Point Avenue, a 3,750-square-foot building renovation in Hunts Point, which was sold to an Opportunity Fund formed by My Tool Rental, a tool rental company based in Brooklyn.
“They ended up taking the benefits of an opportunity fund for the real estate and an opportunity fund for the business,” said Squires, who led the team that represented the seller. “And they did this before the latest guidelines came out. So he could be considered bold. However, Treasury had stated that investors could ‘rely’ on the existing regulations.”
Others have at least started the process, performing some due diligence on possible investments earlier this year with the promise of more regulations.
In one case, Squires said, investors looked at two nearly finished new construction buildings in an opportunity zone. These can be ideal for investors looking to qualify for the opportunity zone tax benefits, though the original builders will not qualify because they did purchase the property through an opportunity fund. Though they will benefit from the profit of the sale of the property, they will need to pay the full taxes.
“There has been a lot of discussion over the ‘substantial improvement’ qualifications for property to qualify for an opportunity fund, but properties also will qualify under the ‘original use’ provision,” Squires said. “In this instance, an investor need only be the first to put the building into service.”
More conservative investors, on the other hand, had opted to wait until the rules were clearer. Wieder observed that some clients are now cautiously interested in finding regions to invest in.
“Treasury wants to give investors clarity,” Squires said. “There were a number of investors on the sidelines who were uncertain. I believe that these guidelines have now given them the confidence to purchase.”
The result should be a flurry of activity in the next couple of years, as the market digests the guidelines. The maximum benefits occur for investments through 2021. Some investors already working in the zones will now have an extra reason to do so.
And more guidance could still come, including more information about how much of a property needs to be an original use, and how funds should be structured.
“A lot of clarity needs to still happen regarding operating businesses other than real estate to qualify,” Squires noted. “But in the industrial area in Hunts Point, opportunity funds could be a real catalyst to create jobs. And for Mott Haven, more residential building will occur.”
Most important, Wieder said, is that investors be ready to pay the taxes due in 2026 on their initial capital gains investments. And note that not all of these investments will work out.
“The deferral is nice, and it is potentially a reduction,” Wieder said. “But you have no guarantee of what tax rates will be in 2026. The real gain here is that 10-year period. Our advice is that you should make a sound investment and not for tax reasons. Ask yourself, ‘Do I like this investment?’ The tax deferral is a bonus.”