6 Things You Need To Know About Investing In An Opportunity Zone

Areas of the U.S. left behind economically after the Great Recession are getting an infusion of private capital and development, thanks to the growing interest in opportunity zones.

A section of the Tax Cuts and Jobs Act, the program offers federal tax incentives for investing unrealized capital gains into opportunity funds, which in turn are used to fuel business and commercial real estate development in low-income communities designated as opportunity zones.

The possibility of deferred capital gains tax and opportunity for lower-cost capital generated by the program have generated interest within the commercial real estate community across assets. Advisory firm Baker Tilly has seen an increase in the number of commercial real estate clients interested in opportunity zones and is already consulting on several deals in the works.

“People are actively investing,” Baker Tilly partner and CPA Randall Barrus said. “Until final regulations are released, there are some unanswered questions out there, but as a firm, we believe there is enough guidance to start new funds and begin to develop or redevelop properties.”

Here are six things you need to know about investing in qualified opportunity zones.

1. Now is the time to invest

Opportunity zones, which have been designated by each state and approved by the federal government, hold their designations for 10 years. During that time, investors can defer paying tax on capital gains by investing those gains into qualified opportunity zone funds, which then invest at least 90% of the pooled capital into these zones through real estate development and/or operating businesses generating new business activity. If the investment is held for at least 10 years, the appreciation on the new investment in the opportunity zone is permanently excluded from taxation.

The tax reduction benefit related to the original investment increases depending on the length of time investors maintain the investment in the qualifying fund. If the investment is held for five years, 10% of the original gain is eliminated. If it is held for seven years or longer, an additional 5% is eliminated. In total, the reduction benefit allows investors to potentially exclude tax up to 15% of the original gain.

Under this timeline, investing in an opportunity zone sooner rather than later could yield greater returns since the reduced tax on the original gain can only be deferred until Dec. 31, 2026 — or the date the new investment in the opportunity zone is liquidated, if not sooner.

“You may want to be conservative in some areas, but deals can be done now and there is a clock ticking,” Barrus said. “For capital gains that are going to be recognized in 2026, to get the full 15% tax deferral, you have to hold it for seven years. The closer you get to 2026, the more likely you are to lose out on that additional discount.”

Investors can also defer the sale of an asset if they want gains to "roll over” into a fund that invests in the zone, Barrus said. Investors have six months from the time they sell their capital gain asset to reinvest the money into a fund, so the longer they can defer the sale of the asset the more time they have to find the right opportunity zone investment.

2. Diversify with asset classes that ordinarily offer lower returns

Because of the higher post-tax return on investment, there is a greater ability to attract more affordable capital, which gives developers an opportunity to attract investors seeking to diversify into assets that would normally yield a lower return. An affordable housing development in an opportunity zone, for instance, could make financial sense for an investor looking to invest gains in an opportunity zone.

“The beauty of opportunity zones, due to the tax benefits for the investors, is that developers can invest in asset types that may produce a lower pre-tax return and ultimately receive a post-tax return comparable to other assets,” Barrus said. “These projects may also serve a greater economic benefit to the community, so it is a win-win for investors and the community.”

3. Geography plays a role

The old cliché that location is everything in real estate is truer than ever with opportunity zones. Different low-income communities require different investment strategies from developers. In rural opportunity zones, industrial development has picked up to relieve pressure on an already supply-strained market, Barrus said. More populated areas tend to focus more on housing, with a focus on workforce development to combat the growing affordable housing shortage across the country.

Investors and developers might also choose locations based on prior experience in the market or existing relationships with local developers. Working in an area where the investor has deployed capital in the past will help deals pencil out on financial documents and draw developers to the opportunity zone.

Baker Tilly has an interactive map that allows prospective investors to view land tracts nominated, certified and designated as opportunity zones. Looking at the map, these zones are spread across most of the U.S. Investors don’t have to go far to find an investment opportunity within these areas. Each governor was able to designate up to 25% of a state’s low-income area as opportunity zones.

“I’ve seen a variety of opportunities throughout the U.S.,” Barrus said. “There are healthy chunks in every state and opportunities no matter where you go.”

4. Consider a joint venture

Should an investor want to explore an opportunity in a new market, a joint venture could grant them access to local resources and knowledge. Joint ventures allow investors to enter an area they are not familiar with by partnering with another company with experience investing in and developing projects in that specific region to discover the best investment opportunities. 

“You are looking at opportunities sprinkled throughout the U.S. and then at developers who may or may not have familiarity in those markets,” Barrus said. “They see an opportunity, but how do they seize it? Having local resources through a JV is the way to go.”

5. Consult an adviser for clarification on certain provisions

While commercial real estate professionals are actively investing in opportunity zones, the program still has several provisions that require further clarification.

The original use provision of the program, which determines qualified opportunity zone properties eligible for investment, defines that asset as a tangible property in which the original use of the property commenced with the qualified opportunity fund. Current provisions don’t specify whether this requirement applies to long-vacant assets.

Additional clarification is also needed on the 30-month requirement for what constitutes a substantially improved property. Under the current definition, following acquisition by a qualified opportunity fund, if the asset has additions to the original value of the asset that exceed the adjusted value as of the beginning of the 30-month period, it is considered substantially improved and is an eligible opportunity zone property.

But the classification doesn’t account for flexibility with timing, should unforeseen requirements impact the 30-month period, Barrus said. Working with an experienced tax advisory firm can help investors account for these uncertainties and create documentation that can adapt to future changes.

6. Build flexibility into your documents

While the Tax Cuts and Jobs Act has been finalized for several months, a number of questions have surfaced about opportunity zones. Legislators might make additional revisions to the law for more clarification. For investors and developers, having financial documents that build in flexibility when it comes to changes can help protect the anticipated tax benefits from their investments in opportunity zones.

As investors look to participate in opportunity zones, it is important to use qualified professionals like Baker Tilly to do the modeling and consult on structuring. For interested investors, successful opportunity fund use is about learning as much as possible about the rules and using resources like Baker Tilly's opportunity zone map to make informed investment decisions. 

“These deals are happening and as far as sitting on the sideline for more guidance, you want to be cautious," Barrus said. "Building a document that has flexibility is helpful and provides enough to move forward.” 

This feature was produced in collaboration between Bisnow Branded Content and Baker Tilly. Bisnow news staff was not involved in the production of this content.