What Are Opportunity Zones in Real Estate?

What Are Opportunity Zones in Real Estate?

When it comes to gentrification, everyone has an opinion. While many welcome it as a sign of progress, others bemoan the associated cultural displacement and higher cost of living. There are different opinions regarding the best ways to improve low-income neighborhoods. Some parties favor direct government investment. Others, including the Trump administration, prefer attracting investors by designating Opportunity Zones.

What Are Opportunity Zones?

An Opportunity Zone is a low-income area in need of investment to improve local facilities and infrastructure. Under the law, if an individual or group invests in a qualified Opportunity Fund, a vehicle that invests at least 90% of its assets in Opportunity Zones, he or she becomes eligible for a series of tax breaks to accompany any rents or appreciation that accrue as a result of the upgrades. As part of the 2017 Tax Cuts and Jobs Act, the Trump administration designated more than 8,700 Opportunity Zones in states and territories across the nation.

The Tax Breaks

Incentives include deferral of capital gains, a step-up in basis, and, for long-term investments, a capital gains exclusion. Tax deferral means that if an investor profits from the sale of a property, he or she can shift the earnings to an Opportunity Fund and temporarily avoid paying taxes. A step-up in basis refers to the calculation that the IRS will make when the investor sells his or her Opportunity Fund investment. The purchase price will be “stepped up” 10-15%, reducing the gain and resulting tax liability.

The final incentive, capital gains exclusion, may be the easiest to understand. It simply means that if an investment in an Opportunity Fund is held for ten years or more, capital gains are excluded entirely.

Opportunity for Whom?

By offering the above incentives, the government aims to free capital that would otherwise go to the IRS. Instead, the capital goes toward bettering low-income neighborhoods. Many investors are still on the sidelines awaiting additional data or guidance from federal agencies. However, if enough people take advantage of the tax breaks and if the Opportunity Zones succeed, less affluent neighborhoods will improve, causing home values in those neighborhoods to increase.

Time will tell whether this benefits the people who presently live in these communities. Meanwhile, the merits of gentrification will remain a topic of intense debate.