Best Practices for OZ Investors

Opportunity Zone investments offer unprecedented tax benefits to shield taxes on capital gains. However, even though they were inked into law in 2017, they are still not well understood by most potential investors. Dreamt up in part by Napster Founder and first President of Facebook Sean Parker, Opportunity Zones were designed as a method for tech workers to shield their stock sale earnings from steep capital gains taxes while offering assistance to poorer communities throughout the United States. Eventually, the provision made it into the Trump Administration’s Tax Cuts & Jobs Act of 2017.

The basis of Opportunity Zone (OZ) investment is simple: tap into billions of dollars of pre-tax capital gains to encourage private equity to flow into underserved and distressed communities. There are more than 8,700 low income census tracts designated by the IRS as Opportunity Zones throughout the United States and its territories. The way OZ investing works is it allows investors who have experienced a capital gain to invest their whole gain (pre-tax) into a Qualified Opportunity Fund (QOF) within 180 days of receiving the gain. The QOF then invests its funds into projects in the census tracts designated as Opportunity Zones, and offers investors favorable tax savings. Today, we will discuss the potential tax benefits for OZ investors and the best practices for making an investment into a QOF. 

Understanding Your Tax Benefits

There were initially a few different tax benefits available to OZ investors. The first benefit is tax deferral. When you invest your capital gain into a Qualified Opportunity Fund, you defer paying your capital gain tax through 2026. For early adopters, there was also a tax reduction on the invested capital gain if the investment is held through 2026. For investments made through December 31, 2019, investors enjoyed a 15% reduction in capital gain taxes on investments held for at least 7 years, through the end of 2026. For investments made in 2020 & 2021 and held at least 5 years, investors received a 10% reduction in taxes. Investments made in 2022 and beyond currently receive no reduction in the taxes due on the original capital gain investment. Complicated enough for you? There’s more! The way the law is written right now, none of this is of any importance to investors who have not made an investment in a QOF yet. However, there is new legislation that could reinstate these tax reductions to investments made from 2021 through 2023. 

The [Opportunity Zones Transparency, Extension & Improvement Act], if passed, would push back the sunsetting of the tax reduction investment date deadlines amongst various other improvements to the original Opportunity Zone legislation. As written, this new legislation would extend the 15% tax reduction timeline to include investments made in 2021 & 2022; the 10% tax reduction would be extended to investments made throughout 2023. The real crown jewel of the tax savings is the tax forgiveness on the new capital gain made off of the OZ investment when investments are held for a minimum of 10 years. While investors will still have to pay their original capital gain tax at the end of 2026 (with or without tax reduction benefits), any gains made on the investment itself will receive a step-up in basis to market value and become tax free. Investments must be made by the end of 2026 under the current legislation, but if the new bill passes the investment deadline would be bumped out to December 31, 2028. 

Best Practices for OZ Investors

When you’re planning to make an OZ investment, there are a few things you should be considering and doing to prepare. 

Select a Strong & Talented Investment Team

Even with great tax benefits available, your returns will still be based on the quality of the investment itself. This means you need to do your homework when selecting a Qualified Opportunity Fund. The management team of a QOF can make or break your investment. Take care to select an experienced team, who has a proven track record in the asset class you’re interested in. Experienced fund managers should be happy to be transparent with you, readily willing to provide you with references from previous and current investors. Also expect them to clearly explain the investment terms and business plan to you, in terminology that you understand. If you feel something is off with any fund managers you speak with, move on to another that you feel comfortable entrusting your money with. 

Do Your Due Diligence in Selecting a region

If you’re not committed to investing in a specific region for personal reasons, it is a great idea to learn about additional benefits that may be offered to Opportunity Zone investments by specific cities or states. For example, some states offer property tax abatements of up to 10 years for improvements made to commercial buildings. Additionally, some cities and towns may change zoning to allow higher density housing in areas where it wasn’t otherwise allowed, or they may modify parking requirements to encourage development in their local OZs. Other indicators of good regions to invest in may include what jobs currently exist in the area, population size, whether there is currently a housing shortage or if one will occur with new jobs being offered, interest and cooperation with local community development organizations, and other planned development in the area.

Utilize OZ Fundhub's investor resources 

Spend some time with the investor resources available for free on ozfundhub.com OZ FundHub is the premier neutral Opportunity Zone resource, built to help investors learn more about Opportunity Zones and get connected to the best Qualified Opportunity Funds that fit their investment needs. Join our OZ Fund Forum to ask questions or participate in discussions with OZ investors, fund managers and area experts. 

Check out our OZ Fund Map to see which areas of the US and its territories are designated as Opportunity Zones. 

Read up on investing tips and tricks, news and all things Opportunity Zones on our blog, and our social channels: LinkedIn, Facebook, Instagram and Twitter. Also, download our Investor Guide and other resources in our Learning Center.

Don't miss your 180 day window

Our final best practice, and perhaps most important, is not to miss your investment window. In order for your investment to be eligible for Opportunity Zone tax benefits you must make your investment into a Qualified Opportunity Fund within 180 days of realizing your capital gain. So, if you’re expecting a capital gain or are already in your 180 day window, get connected with QOFs that fit your investment needs today with  our OZ Fund Finder.