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Potential Tax Advantages
OPPORTUNITY ZONES AND OPPORTUNITY FUNDS
The Tax Cut and Jobs Act of 2017 created Opportunity Zones and authorized a new investment vehicle knows as an Opportunity Fund. Opportunity Zones and Opportunity Fund can offer substantial Tax Advantages to Investors with capital gains tax liability from prior investments.
If a sufficient number of potential investors would qualify to take advantage of the benefits under this program, management would consider restructuring the offering, or a portion of the offering, as an “opportunity fund” in order to take advantage of this program.
The following summary provides an overview of this program.
POTENTIAL TAX ADVANTAGES
Opportunity Funds offer three tax benefits: (i) Tax Deferment, (ii) Tax Abatement and (iii) Tax Avoidance.
Tax Deferment - Similar to a 1031 exchange, if someone has a capital gains tax liability from a prior investment and within 180 days of the recognition of such gain they reinvest their profits in an Opportunity Fund, the payment of their capital gains tax is deferred until the sale of their investment in the Opportunity Fund or until December 31, 2026.
Tax Abatement – An investment in an Opportunity Fund also provides for an abatement of the original tax liability. If the investment in an Opportunity Fund property is held for Five 5 years the original tax liability is reduced by 10%.
Tax Avoidance - The biggest Tax advantage concerns the new Opportunity Fund investment is tax avoidance. If the Opportunity Fund investment is held for more than 10 years you pay no capital gains tax on the new Opportunity Fund investment when it is sold.
Opportunity Funds have a number of advantages over 1031 exchanges. An Opportunity Fund investment does not have to be like real estate for like real estate. Opportunity Funds allow gains from the sale of stock, LLC interests, real estate and other property to be invested tax deferred in unlike property or business located in a zone. Opportunity Funds also allow more flexible investment structures compared to the Tenant in Common (TIC) and Delaware Statutory Trust (DST) structures utilized in 1031 exchange offerings.
The designation of Opportunity Zones is designed to help spur the development of identified communities. In exchange for investing in Opportunity Zones, investors can access capital gains tax incentives available exclusively through Opportunity Zones. To access these tax benefits, investors must invest in Opportunity Zones specifically through Opportunity Funds. A qualified Opportunity Fund is a US partnership, limited liability company or corporation that intends to invest at least 90% of its holdings in one or more qualified Opportunity Zones.
As previously mentioned, Opportunity Funds are governed by IRC section 1400Z-2 and Opportunity Funds can self-certify to the IRS. But each Opportunity Fund is responsible for ensuring that they abide by the guidelines of regulations in order to be able to offer tax incentives.
Because Opportunity Zones are intended to stimulate positive growth within designated communities, there are restrictions on the types of investments in which an Opportunity Fund can invest. These investments are called “Qualified Opportunity Zone property,” which is defined as any one of the following:
- Partnership interests in businesses that operate in a qualified Opportunity Zone.
- Stock ownership in businesses that conduct most or all of their operations within a Qualified Opportunity Zone.
- Property such as real estate located within a qualified Opportunity Zone.
There are rules that govern each of these three investment options, but the rules for businesses are similar to those of the Enterprise Zone Business requirements. For property such as real estate, the rules are somewhat different. The types of real estate investments allowed under regulations are limited to ensure that the communities are improved with each investment.
Essentially, Opportunity Funds can only invest in the construction of new buildings and the substantial improvement of existing unused buildings. If an Opportunity Fund invests in the improvement of an existing building, it must invest more in the improvement of the building than it paid to buy the building. Whether the building is constructed from the ground up or improved, the development of the building must be completed within 30 months of purchase.