Opportunity Zones: How They Work & Their Potential Impact on Economic Development
I recently attended a workshop at City Hall, which centered around Opportunity Zones. I wanted to share what I learned and what I think about them. There are still some things I'm not clear on, and I am not a tax expert, so anything that I write on the subject could be wrong. Anyway, here is what I came away with.
Overview: What are Opportunity Zones?
In 2017 Congress passed the Tax Cuts and Jobs Act, which introduced a new program called the Qualified Opportunity Zone (QOZ). This program was created to foster economic growth in economically-distressed census tracts through tax benefits to investors.
In order to take advantage of the tax benefits, investors need to invest through Opportunity Funds, which can be a partnership or a corporation organized for the purpose of investing in Opportunity Zone properties.
Capital gains reinvested within days 180 into a Qualified Opportunity Zone are not taxed until 2026.
If investor holds interest in the fund for five years, 10% reduction in tax on the gain.
If investor holds interest in the fund for seven years, 15% reduction in tax on the gain.
If investor holds interest in the fund for ten years, 100% reduction in tax on the gain from the sale of the asset in the fund.
**Disclaimer** I am not a tax professional, and I am not qualified to give tax advice. Anything that I say regarding taxation could be incorrect. See a tax specialist for tax advice.
Similar programs have been implemented at the federal level in years past, but never to this extent, both in terms of the amount of area, and in size of tax incentive. 38 Empowerment Zones, 40 Renewal Communities, 115 Enterprise Communities vs. 8,762 census tracts (1/8th of all total US census tracts). The tax advantages of each of those programs were significantly less impressive, and included a wage credit of up to $3,000 for each employee living and working in an Empowerment Zone, an increase of $20,000 in depreciation expensing limits, and a tax-exempt bond for expansion projects.
Another advantage that this program has is flexibility. Opportunity Funds can invest in a wide variety of assets, including stocks of new companies, real estate, and infrastructure. Opportunity Zones could potentially revitalize more than just residential properties by freeing up funds to improve infrastructure, remediate brownfields, and invest in small, local businesses.
Pros and Cons of Opportunity Funds as Investments
Con: No disparity pricing
When you buy into a fund, it's a lot like buying stocks; prices are what they are from day-to-day. This is very different from real estate investing, which often utilizes the purchase of undervalued properties; hence the phrase "You make a profit when you buy, not when you sell."
Pro: You can sell off stocks to get into real estate.
The hype around deferring capital gains for a real estate investment is somewhat deceiving, since a 1031 exchange has already been a vehicle for that. However, what is interesting about Opportunity Fund investments is that they include stocks, bonds and other appreciated assets, which one could sell to get into real estate via OZs. That being said, if you already own investments in real estate, you could do almost the same thing with a 1031 exchange.
Con: No ability to leverage debt
With these funds, there is no ability to see the kinds of returns that real estate investors typically see with leveraged investments. I have heard that "leverage amplifies loss as well as gains," but if that was a concern, I wouldn't invest in it to begin with.
Opportunity Zones in the Cape Fear
The tri-county area contains a total of 9 opportunity zones; 3 in Brunswick, 2 in Pender, and 4 in New Hanover.
In New Hanover County, there are three OZs adjacent to each other in the southern part of Downtown Wilmington, beginning at Market St and ending at Greenfield Lake, and one larger OZ in Midtown, which encompasses UNCW and surrounding neighborhoods. In Pender County, the two adjacent zones are primarily in Rocky Point, and in Brunswick, the zones include much of the rural part of the county and Navassa.