Wednesday, September 8, 2021

OZ, by any other Name, could be a Profitable Opportunity!

Qualified Opportunity Zone Map for USA
Opportunity Zones present a hidden opportunity for Real Estate (RE) investment that should be widely utilized across the US. Why not? (View Interactive HUD Map here.)

There’s a spectacular investment tool that was associated with tax cuts of 2017 by the Trump administration. Along with the massive tax cuts, there was a non-partisan tax break to funnel private investments into underdeveloped communities around the nation.

It took a couple years for the census tracts in every state to be identified and for the final definition of the program. There are 8,700+ census tracts across the US that are designated as “zones”. Most people are surprised to find that they live in, or within a few miles, of one of these special tax – legal loophole – areas. There are at least two major reasons why these special zones have not received substantial attention and engagement: massive confusion related to the name, Qualified “Opportunity Zone” (QOZ); and, the COVID pandemic/recession.

OZ, We’re not in Kansas Anymore, Toto.

Using the term “Opportunity Zone” for these census tracts across the nation, was a horrible idea. People think of Enterprise Zones (EZs), Industrial Parks, Community Redevelopment Areas (CRAs) and such when they hear “Opportunity Zone”. Enterprise Zones are usually a specific campus or industrial park, so a business has to locate, or relocate there. Plus, an EZ usually has specific target business development such as light-industrial, or high-tech research. Business incubators often are located inside an EZ.  Foreign Trade Zones (FTZs) might be added to EZs where there is a port (or airport) of entry to enjoy special import/export treatment. Anyone, and everyone, who hear about Qualified Opportunity Zones for the first time have to disconnect their thinking from the historic use of “Opportunity Zones”. Essentially, we’re not in the land of OZ anymore, we’re in a qualified version of OZ, a Q.O.Z. Maybe a better approach would be to redefine a term or acronym for QOZ. It is a legal tax loophole related to designated census tracts; maybe calling it something a Qualified Opportunity Tax Area would be better. Let’s use QOZ for the qualified tax areas; and QOZ-Fund for the formal bank account of the qualified company that manages QOZ funding and reports to the IRS; and QOZ-Property for the real estate investments that are central to the QOZ project.

Probably and equal put-off is that an investment in a QOZ goes into a “Fund”. This sounds complicated, a lot like setting up and managing your own mutual fund; however, it is surprisingly straight-forward.  Essentially, set up a bank account specific to the real estate investment within a qualified census tract; let the IRS know on a form (Form 8997) that money has come in from capital gains of an investor; and later let the IRS know that the property has been sold and that taxes are now payable. (Taxpayers file a Form 8949 each year illustrating how much capital gains tax continues to be deffered.) The investors’ capital gains taxes could, and should, be much lower in addition to being deferred.  The funding associated with such an investment is called an Opportunity Zone Fund (QOZ-Fund).

The Opportunity Zone program creates a tax incentive for individuals who reinvest unrealized capital gains into high-impact, long-term projects in high-poverty communities across the country. It is based upon bipartisan legislation authored by U.S. Senators Cory Booker (D-NJ) and Tim Scott (R-SC). (Booker press release, Oct 31, 2019)

The Opportunity Zones provision is based on the bipartisan Investing in Opportunity Act, which was championed by Senators Tim Scott (R-SC) and Cory Booker (D-NJ) and Representatives Pat Tiberi (R-OH) and Ron Kind (D-WI), who led a regionally and politically diverse coalition of nearly 100 congressional cosponsors. (Economic Innovation Group,

Who should consider QOZ projects?

Answer 1: Anyone involved in real estate in or adjacent to a designated QOZ census tract. This, of course, includes Realtors® and mortgage lenders, builders, and contractors. (Illegal businesses, and “sin” businesses like cassinos, do not qualify.) There are the parties that are exchanging property in a real estate sale, of course. The seller would likely have capital gains from the sell of the property that could/should be invested somewhere; and a QOZ fund investment would allow for deferring or completely avoiding taxes on the capital gains. The buyer(s) might want to purchase using their own capital gains (from any source). Even outside parties might want to jump in and invest in a real estate (or development) project so that they can avoid and defer paying capital gains taxes.

Answer 2: Anyone with capital gains should be interested. This introduction of outside parties to a real estate project within a QOZ is probably the biggest paradigm shift for many people. Everyone is comfortable with bank (debt) financing but using outside (equity) investors may be novel for many real estate developers. There is no reason to avoid debt (bank) leverage, but the change in ownership will restructure the funding from all sources.

Investors: Capital Gains and Benefits of Taxes Avoided/Delayed

The beauty of compounding is an almost magical thing. A 7% return on investment would double in value about every 10 years. So, a $100,000 investment might easily grow to a $200,000. That is a reasonable investment growth rate for the value of real estate, even if there were no improvements or operating profits (like from apartments or offices). But the investment in a QOZ Fund would be from moneys that would otherwise be subject to capital gains taxes. For most investors this would be 20% or higher tax rates. So instead of investing the $100,000, taxes would go to the IRS leaving only about 80,000 to invest today. Stated differently, to make the $100,000 investment today, you would need $125,000 of money that was taxed at 20% capital gains. (Capital gains can be much higher, especially for short-term capital gains.)

QOZs are a longer-term investment tax mechanism. If you keep the investment for 10 years, you pay no taxes (0% tax rate) on the “profits” when you sell and cash out of the investment. Wow!... And the taxable amount of your original investment will be reduced by approximately 10% if you keep the money invested for 5 years (or more). There is a deadline of December 31, 2026 to reach the 5 year deadline; this deadline puts some pressure to complete a QOZ investment into a fund by the end of 2021. After 2021, the 5-year stepdown of 10% will no longer be possible, but taxes on the original investment will still be deferrable until the end of 2026. (There was an additional tax break at 7 years, but that stepdown of taxes is no longer possible because of the 2026 deadline.)

Eventually, you have to pay capital gains on at least part of the original investment, but the time that taxes are deferred is time in which the compounding of the investment works in your favor. This is a little like a traditional IRA, you invest tax-free money today, but pay taxes in 30 years when you start to withdraw; but during that 30-year period your money plus the money that would have gone to the IRS for taxes has been working for you. Hopefully, doubling, and then doubling again.

Map of QOZ Investment Tracts

How do you know which areas are designated for this special OZ tax treatment. The Housing and Urban Development (HUD) has an interactive map that allows you to zoom in on a region to find the census tracts that are given this special investment status. See the US Map of QOZ census tracts at HUD:

Some listing services show properties that are in QOZs. So, your favorite Realtor would be able to tell you when properties you look at are within QOZ tax havens. QOZ status should help to bolster property values. Alaska has massive QOZ tracts, and all of Puerto Rico is a QOZ.

There are several groups who gather QOZ investment opportunities around the nation and investors with capital gains to invest. One group,, does podcast and provides a catalog of various QOZ projects. Many Banks and investment houses will assist in creating a QOZ or with finding Funds to consider for investing your capital gains.

Capital Gains in the Future

The future is uncertain. Many people find themselves locked into assets (stocks, real estate, etc.) because selling them would incur a huge tax on capital gains. Stocks that you bought in a brokerage account at $10 per share are now at 10 times that. Virtually all capital gains! The QOZ program is a mechanism to jump out of investments that are in a Capital Gains Trap.

If you bought property for $1,000 and now it will sell for $50,000? Well, there is a mechanism for “like” real estate investments where you can move your investment (and profits) from one property to another. But there are lots of restrictions to this 1031 tax deferment. Plus, you now have your principle and profits tied up in the new real estate.

But, if you cash out your profits this year, and know that you will have to pay capital gains – at least in part – in 5 years, then you might be worried about the capital gains rate going up under a Democrat/Biden Federal Government. (Capital gains would be the most likely, if any, of the possible tax hikes within the next 10 years.) But with an QOZ, you are taking out capital gains now, with the expectation of reducing tax payments in the future and avoid all taxes on the profits this investment generates. If you keep your current capital gains locked up, the lock would be even worse if/when capital gains rates go up in the future. Essentially, the Capital Gains Trap gets even bigger.

On the tax side, if you invest in a QOZ in 2021, you should start to manage your cash flows for paying some taxes on your capital gains in 5 years. Your tax forms show (much like your IRAs) how much money you have in tax-deferred status. Paying taxes in 5 years, is usually better than paying taxes today.

Profits are a Wonderful Thing

You should rejoice in making profits. All things equal, you should prefer to pay higher taxes because that means that you are making a lot of income (profits). In general, you should make your finance and investment decisions without considering taxes, and then factor in the tax implications. A good investment will rarely be negated by the tax adjustments; but a marginal investment might be swayed by tax considerations. Evaluate carefully where you invest to make sure the QOZ investment is a profitable venture prior to any tax benefits.

You should never make financial decisions solely based on taxes.  Many people have much of their life’s savings tied up in a couple asset (classes) that are heavily subject to capital gains taxes. The QOZ investment mechanism is a great way to work on cashing out of some of the “capital-gains locked assets”.

It is surprising how little the QOZ tax deferral program seems to have been utilized. Makes you wonder why?

The IRS provides questions, answers, and a lot of confusion on the topic. Be sure to seek advice from professionals who have QOZ knowledge and experience (CPA, RE Attorney, Financial Planner, etc.) before making the leap into – and out of – QOZ investments.  Of course, if you are single, you can try to marry someone who has lost lots of money; then your profits might wash with their losses. What could go wrong with that strategy?

QOZ tracts for Florida and Pennsylvania.

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