There isn’t much time left for real estate investors to take advantage of one of the biggest perks of opportunity zones.
Opportunity zones—a program started under the Tax Cuts and Jobs Act of 2017—are economically distressed areas where the government hoped to create jobs and increase spending through tax incentives to investors.
The perk, coming to an end on Dec. 31, is a 10% exclusion of the deferred gain if the OZ investment is held for at least five years.
For example, if an investor has $1,000 in capital gains, puts that money into an opportunity zone investment before Dec. 31 of this year and holds it through the same time in 2026, they receive the benefit of having 10%, or $100, excluded from tax.
The Dec. 31 deadline is drawing increased interest from real estate investors. “We’ve seen a slight uptick in the last few months of people who are looking to take advantage of the program and see that tax benefit,” said Troy Merkel, senior real estate industry analyst and partner at RSM.
Craig Mason, tax partner at RSM, expects that there will be an influx of money into opportunity zone investments in the final weeks of 2021.
“People have more confidence in the economy and the state of the real estate market now,” Mason said. “With the deadline approaching, there’s no reason to think that opportunity zones will not attract additional capital.”
There are also benefits to investing in opportunity zones past 2021. Investors will still be able to invest that same $1,000, hold the OZ investment for 10 years, and pay no tax on the gain.
Here are a few questions investors must ask themselves about opportunity zones before investing.
Will tax rates rise?
If you believe that tax rates are headed higher under the current administration, it may be best to hold off on opportunity zone investments unless you find a fantastic project, according to Mason.
“There are a lot of advantages to getting a 10% increase for a five-year hold,” he said. “However, if there’s a substantial tax increase, that that could play negatively for that investor. Investors have to decide when and how much to invest.”
Should opportunity zones be considered past New Year’s?
Scott Helberg, a senior real estate industry analyst and senior tax manager at RSM, tells investors that they can’t let tax breaks drive their decision-making. If investors find a good deal past 2021, the benefits of opportunity zones can make it even sweeter, he said.
“At the end of the day, the investment still needs to be a good investment,” Helberg said.
Or, as Mason said: “Opportunity zones can make a good deal great, but a bad deal is a bad deal.”
For investors who are going to make an investment that qualifies for an opportunity zone benefit past 2021, Merkel said there’d be no reason not to move ahead.
“It’d be a way to enhance an investment that you would make because of its economics,” he added.
Will the current administration change the OZ program?
Opportunity zones were created under the Trump administration. So far, Merkel said, the Biden administration said that it would not alter the program.
“Now, the concern is whether there’s too much government subsidy going into the economy and too much investment,” he said. “That’s probably going to temper the program going forward.”
The $1.2 trillion infrastructure bill passed on Nov. 15 and the administration recently finalized its proposed reconciliation bill—neither mentioned opportunity zones, Helberg said.
“Could a piece of one-off legislation happen? It’s certainly possible,” he said. “But it seems things may remain as they are for the time being.”
Does my state recognize opportunity zones?
Helberg said that investors must ensure that their state recognizes the tax deferral of opportunity zones.
“California is one example where the state does not conform with the federal initiative,” Helberg said. “It is important to consider the state income tax implications when evaluating the costs and benefits of investing in an opportunity zone.”
What’s the societal impact?
There’s been criticism of the impact of opportunity zones. Journalist David Wessel, for example, said that opportunity zones have benefited rich people more than anyone.
Mason contends the criticism is premature. “You’re just now getting a lot of projects off the ground,” he said. “And projects don’t happen overnight. It takes a while to start up.”
While statistics have been slow to come in on opportunity zones, the Government Accountability Office recently released numbers on the program for 2019. The GAO reports that more than 6,000 Opportunity Funds with nearly 18,000 investors owned $29 billion in qualified opportunity zone properties over that year.
“Nearly all funds are investing in real estate developments, many of which are complex, multiyear projects such as hotels and multifamily housing projects,” the GAO report found.
Helberg agrees it’s too soon to judge whether OZs have improved economically marginalized areas. Just like money deployed to other real estate projects—particularly those that need significant redevelopment—impact won’t be apparent immediately.
“The pandemic has had a significant impact on getting permit approvals, getting construction moving, acquiring materials in the face of increasing costs—there certainly have been plenty of obstacles over the last couple of years,” Helberg said. “It’s going to take time to fairly evaluate the social impact of those investments.”