Tax season can introduce a whole host of decision-making challenges into an investor’s portfolio. Some assets can be sold to harvest losses, while others may be sold because it is a profitable time to sell.
For investments that have generated capital gains, there are further decisions to make—is it time to pocket the profit and pay taxes? Or are there opportunities to defer capital gains taxes and generate tax-free growth by investing in new assets?
September 11, 2023 serves as the deadline for certain 2022 capital gains to be invested into tax-advantaged investments in qualified Opportunity Zones, coming 180 days after the March 15, 2023 reporting of certain 2022 capital gains. For investors who have capital gains generated in 2023, there is still time beyond Sept. 11 to invest in Opportunity Zones.
For eligible investors, investments of capital gains into Qualified Opportunity Zones can provide an avenue to defer federal capital gains taxes by several years and provide a path to earn long-term capital appreciation that is exempt from federal taxes, and in many cases also exempt from state tax, if held for ten years or longer.
How Can I Invest in Opportunity Zones? Qualified Opportunity Zone Funds are investment vehicles that are typically focused on developing, financing, and operating new commercial real estate properties located in an Opportunity Zone. These funds may additionally make a commitment to integrating positive social and economic impacts into each development project in the form of creating new jobs, promoting long-term economic activity, and providing positive environmental and other community benefits. Investments of capital gains into QOZF’s need to be held for at least ten years realize many of the potential tax benefits, so these investments are most attractive to investors with a longer-term investment horizon.
How Do I Choose the Right Fund? Successful OZ investments require careful selection of markets, assets, sponsors, and deal sizes that align with long-term investment goals. At Revitate, we focus primarily on investing in certain sectors of commercial real estate, such as multifamily apartments and industrial properties, based on a specific outlook about which real estate sectors are likely to have the best risk/reward characteristics over the next 10 years.
Some QOZ funds have also found value by investing in secondary markets due to strong macro-level fundamentals. As a result of the COVID pandemic in 2020 and 2021, remote work, and other factors driving recent migration patterns, certain less populous counties gained population at the expense of the more populous ones. Investors following these migration patterns have been able to find attractively priced land, attractive deal structures, and strong tenant demand for new apartment communities and other commercial properties.
Investors and investment advisors should consider firms that have an experienced leadership team, a reputation for thought leadership in QOZ’s, good judgment, and sufficient capital to serve as an attractive long-term partner for the ten-year minimum holding period and beyond.
What are the Tax Advantages for Investing Capital Gains into Opportunity Zones? Your tax advisor can help you determine which of the many tax advantages relating to QOZ investments are available to you. Sales of appreciated public equity, entrepreneurs selling their businesses, or real estate dispositions. Eligible capital gains may include gains generated from selling appreciated public or private securities, the sale of a business, certain real estate dispositions, and other sources.
Generally, an investment into a QOZ fund may allow the investor to defer paying federal capital gains taxes (and in many cases also defer paying state capital gains taxes) until 2026 or 2027 depending on the investor’s tax reporting periods. A potentially more significant tax advantage is that future gains on eligible QOZ investments are exempt from federal taxes (and in many cases also from state taxes) if sold after the ten year minimum holding period. The combination of near-term tax deferral and long-term tax-free gains can be compelling for many investors, particularly as compared to paying the tax now and reinvesting in assets that are subject to future long-term capital gains taxes. QOZ investments can also be a useful tool for long-term tax planning and estate planning.
Investments in Opportunity Zones can provide compelling tax benefits to encourage investors to invest in America’s long-term economic growth.
Robert Lang is Managing Director of Commercial Real Estate for Revitate, an alternative investment firm that specializes in opportunity zones.