Invest Ahead of the Curve

A comprehensive guide to navigating Opportunity Zone investments and maximizing returns

The 2017 Tax Cuts and Jobs Act [TCJA] established over 8,700 federally designated Qualified Opportunity Zones [QOZs] throughout the US in census tract areas selected by the governors of each state. These QOZs were created to spur economic growth and development by extending generous tax incentives to investors who invest their capital gains into Qualified Opportunity Funds [QOFs], which in turn acquire assets located in these Zones.

Calculate Your Potential After-tax Returns

*calculations assume 10% returns for a 10-year period

The Opportunity: Tax Incentives

Temporary Deferral

Investors who realize ANY capital gain (sale of a company, stock, property, etc.) and invest in QOFs may defer paying taxes on these gains for up to 7 years. To qualify for the maximum deferral, the deferred gain must be recognized on the earlier date of when the Fund interest is sold or December 31, 2026.

Step-Up in Basis

After 5 years of holding assets in a QOF, investors qualify for a 10% step-up in basis on their original gain; after an additional 2 years (total of seven), investors qualify for a total step-up of 15%. To qualify for the maximum 15% tax exclusion on the original capital gains, investors must invest by December 31, 2019.

Permanent Exclusion

After 10 years of investment in a QOF, any appreciation on the original fund investment may be entitled to permanent exclusion from taxable income of all capital gains related to the sale or exchange of QOZ assets (i.e. tax-free growth on investment).

How QOZs Work

Examples of QOZs with Strong Outlooks

Provo, UT

Designated by Cushman and Wakefield as North America’s fastest-growing tech employment market, Provo, Utah has distinguished itself as a top destination for start-ups and corporations, alike. In recent years, Downtown Provo has undergone an extensive revitalization, contributing to the city’s recently earned title as Gallup’s “#1 Best Place to Live.” In an an ongoing effort to support business expansion and development, the U.S. Department of Commerce awarded a $1.8 million grant to the Provo City Corporation of Provo, Utah for roadway and utility infrastructure. Projections show the investment will spur $35 million in private investment projects, including the Downtown Apartments and Provo Office and Parking Projects – both located in QOZs that forecast even stronger and steadier growth into the future.

DOWNTOWN APARTMENTSPROVO OFFICE AND PARKING

Salt Lake City, UT

Ranked #1 by Forbes for “Best Cities for Young Professionals” and consistently ranked in the top 10 cities for population growth, Salt Lake City continues to see growth and demand for multifamily housing, especially in its downtown business hub. In 2017, US News & World Report ranked Salt Lake City #15 on its list of “Best Places to Live,” citing the city’s night life, affordability, and proximity to outdoor recreation as major draws. From the Paperbox Apartments located half a block from the Utah Jazz’s Vivint Smart Home Arena to the Main Street apartment complexes perfectly positioned to provide convenient access to city light rail, the future is bright for strategically developed QOZ projects in this vibrant, up-and-coming area.

PAPERBOX APARTMENTS | BOUTIQUE HOTEL SLC | 4TH SOUTH MAIN ST. APT.

7TH SOUTH MAIN ST. APT. | SHIPEX INDUSTRIAL | MILLCREEK PHASE 2

Ogden, UT

Affordability, access to higher education, and proximity to one of the largest hospitals in Utah earned Ogden its title of “Forbes #1 Best City to Raise a Family.” This popular place to live is home to Weber State University, the second largest college in Utah, which boasts more than $132 million in annual endowment and currently educates 27,000+ students. As population and job growth continue to create demand in Ogden, QOZ projects including Ogden Contempo Apartments and the Ogden Office development will become increasingly valuable. Ogden Contempo Apartments are located along the beautiful Ogden River adjacent to the downtown district, allowing residents to easily enjoy charming retail, dinning, and entertainment destinations. The Ogden Office development stands in an area known for its large manufacturing industry, proximity to Hill Air Force Base ($3 billion in economic impact), and headquarters of MarketStar, Autoliv, Bank of Utah, and America First Credit Union.

OGDEN OFFICE

Scottsdale, AZ

Home to Arizona State University and company headquarters of Vanguard, Honor Health, GoDaddy, Massage Envy, and CVS, Scottsdale has become a major hub for business expansion and job growth. Additionally, the economic hot spot has distinguished itself as a major destination for tourism, boasting more than 11 golf resorts, hosting MLB Spring Training, drawing more than 9 million visitors annually, and creating an economic impact of $3.7 billion. Soon, the community will welcome a large 537,000 square-foot QOZ development consisting of two hotels, office space, retail areas, and multifamily housing called the Oldtown Scottsdale Project. Located within walking distance of Scottsdale Fashion Square, the new gathering place will enhance the way people live, work, shop, and vacation in downtown Scottsdale.

OLDTOWN SCOTTSDALE PROJECT

Rochester, MN

As the second largest city in Minnesota, Rochester is one of the major centers for business and growth in the state. Additionally, as home to the world-renowned Mayo Clinic, which employs more than 32,000 people, Rochester is known for its abundant medical resources and aggressive plans for expansion to further attract patients from around the world. To aid continued growth, the City of Rochester has launched an initiative to allocate $6.2 billion to private/public partnerships and his committed $600 million to build a light rail system. With limited extended stay options, Rochester is now welcoming a new Hyatt House hotel, a QOZ project, directly adjacent to the Mayo Clinic. Slated to break ground in 2019, the outlook for the future of this property is very strong.

ROCHESTER HYATT HOUSE

Danger Zones

 

While the Opportunity Zone program potentially offers a once-in-a-lifetime opportunity (pun intended), it is not without pitfalls. Investors must be careful to find Fund managers who will both comply with the regulatory constraints and make fundamentally sound investment decisions. We have identified 4 key considerations that will help you avoid turning an Opportunity Zone into a “Danger Zone.”

Questionable Locations

Not all Opportunity Zones & Opportunity Zone Deals are created equal. Each state had the discretion, within certain guidelines, to designate the zones within their borders. Predictably, different state governments took varying approaches to designating areas – some much more investor friendly than others. For instance, it is not difficult to understand that the risk/return profile of a QOZ in downtown Hollywood might be better than rural farmland in Montana. Simply carrying the QOZ designation does not make a site an attractive investment. This should be self-evident, but beware of “wolves in sheep’s clothing” being peddled by commercial brokers:  undesirable land dressed up with the Opportunity Zone label hoping to trap some unwise opportunist with the promise of a massive tax-free gain. Not every asset or deal is the best fit for a site, even when considering the QOZ tax benefits.  A deal should stand on its own, independent of tax benefits. A good deal is a good deal regardless of any special tax enhancement. Beware of anything that only looks attractive when looked through the lens of after-tax returns.

 

Limited Track Records

Development (or heavy value-add) deals are difficult to execute well.  By definition, opportunistic real estate investing (development, redevelopment, heavy value-add) is the riskiest type of real estate investing – you are trying to predict the future by creating a product that does not currently exist and anticipating a demand that has not yet proven itself in reality.  As such, investors demand a higher return from development deals than they do from all other types of real estate transactions because of the commensurate risk.  It might seem easy:  find a piece of land, hire an architect and engineer, develop plans, work with city planning, hire a general contractor, build a building, and hire a property management company to lease it up.  However, do you have the ability to identify the highest and best use for a site, to know exactly what demand factors exist (or will exist when the building comes online), how to manage a project so it hits your forecasted budget and schedule, and how to most rapidly stabilize the asset?  Once all of those things are done, do you know how to position the asset for sale at the highest price possible?  There are very few developers who survive economic cycles with the skills and experience to consistently execute development projects well.

Undefined Safeguards

Regulatory Compliance is the least sexy “Danger Zone” here but merits just as much consideration as the other areas.  As an investor contributing gains into a QOF, you are completely reliant on that fund manager to (a) keep you compliant and (b) ensure that you capture the maximum allowable benefit under the law.  Accordingly, it would be unwise to partner with groups that have little or no experience dealing with creating and administering capital vehicles with multiple investors.  By definition, every group will be forming their first QOF, but some of these GPs will have significant experience with previous investor vehicles of varying type and complexity.  Take time to review this history and also understand who their tax, legal, and compliance advisors are.  For instance, who helped them form their fund, who will perform the annual audit, and what compliance procedures do they have?   

 

Unidentified Projects

Avoid investing with funds that have not identified deals.  As we’ve previously noted, there is already a rush of capital chasing a very finite number of deals that have inflated asset prices even before any QOFs get off the ground.  PEG Companies, the developer and investment firm that operates opportunityzones101.com, has been approached with term sheets from a number of large, name brand real estate platforms that are raising large QOFs and hoping to white-label PEG’s deals for their own fund.  We know that these large groups are having a much harder time identifying deals than they had anticipated, and in many cases, already have investor dollars committed without a place to put them.  You don’t want to get caught in a vehicle like this with a ticking clock and a looming tax bill.

 

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Important Dates

180-day window to reinvest capital gains

In order to qualify for the Opportunity Zone benefits, the taxpayer must reinvest their gain amount into a Qualified Opportunity Fund (QOF) within 180 days of the gain realization event. For example, if your event occurred on December 1, 2018 you would have until May 30, 2019 to reinvest your gains into a QOF. There is a variation for partnership vehicles, however, in which the 180 day clock begins at the end of the partnership’s taxable year. For example, if you realized gains within a partnership on March 27, 2018, your 180 period would begin on December 31, 2018 and expire on June 30, 2019. In either case, you must elect to defer the gain when filing your taxes via IRS Form 8949.

December 31, 2017 - January 1, 2027 – Window of sales that qualify

Capital gains in the Opportunity Zone program must arise from a sale occurring AFTER December 31, 2017 and BEFORE January 1, 2027 (tax benefits decrease for capital gains occurring after 2019, due to the 5 years and 7 years hold requirements for the 10% and 15% step-up in cost basis, respectively AND the December 31, 2026 rule).

December 31, 2019 – Deadline for 15% tax exclusion

Invest in a QOF by this date in order to be entitled to the maximum tax deferral, 15% step-up in cost basis at 7 years (pay taxes on 85% of the original capital gain).  To maximize the full tax benefits of investing in a QOF, investors will want to invest in a QOF by the end of 2019.  Only by doing so before this date will investors be able to recognize the 15% step-up in cost basis (decreasing tax liability) by December 31, 2026, seven years from December 31, 2019. 

December 31, 2021 – Deadline for 10% tax exclusion

Invest in a QOF by this date in order to be entitled to the 10% step-up in cost basis at 5 years (pay taxes on 90% of the original capital gain).  To recognize some of the tax benefits of investing in a QOF, investors will want to invest in a QOF by the end of 2021.  Doing so before this date, investors be able to recognize the 10% step-up in cost basis (decreasing tax liability) by December 31, 2026, five years from December 31, 2021. 

December 31, 2026 – Deadline to recognize maximum deferred gain

Investors will need to recognize the deferred gain on the earlier of two dates: 

  • The date you sell your interest in the QOF, or 
  • December 31, 2026 (the gain will be recognized on your 2026 tax return)
December 31, 2047 – Deadline to receive 100% tax exclusion

Sell your QOF investment by this date in order to get the 100% exclusion of all the gain from an investment in a QOF (minimum 10-year hold).  In order to be entitled to the full 100% exclusion of taxes on any appreciation/gains from your investment in a QOF, you must sell AFTER 10 years of the investment in a QOF or by December 31, 2047. 

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