An Innovative Investment VehicleThe Tax Reform bill created a new investment vehicle called Opportunity Funds. These Funds are intended to help low-income and underdeveloped communities, identified as Qualified Opportunity Zones. Although new and untested, these Funds can offer very valuable tax benefits to investors including:
- Deferral of capital gains
- Reduction of gain through a basis adjustment
- Permanent gain exclusion from investing in an Opportunity Fund
Let's get into the details.
What Is an Opportunity Fund?The Funds were created by the recent Tax Reform bill to spur real estate development and redevelopment in Qualified Opportunity Zones. Zone applications had to be submitted earlier this year by the Governor of each state. At this time, there are 126 such Zones in Colorado and 628 in Texas, with a total of 8,762 Zones nationwide.
To achieve Opportunity Fund status, the fund must invest at least 90% of its assets in property located within a Zone or Zones.
What Are the Tax Benefits of an Opportunity Fund Investment?As mentioned in the introduction, there are several tax benefits of an Opportunity Fund:
- An investor who realizes a capital gain has up to 180 days to reinvest the proceeds in an Opportunity Fund in order to defer having to pay current income tax on the capital gain.
- If the investor holds their Opportunity Fund investment for at least 5 years, they can increase their cost basis by 10% of the deferred gain.
- If held another 2 years (7 years in total), they can increase their basis by another 5% of the deferred gain.
- If the investor still holds the Fund investment on December 31, 2026, they have to recognize the remaining 85% of the gain and pay tax with their 2026 tax return.
- If the investor continues to hold the Fund investment beyond 2026 and for a minimum of 10 years total, then any gain on the appreciation of the Fund investment becomes tax-free.
What Property Qualifies for an Opportunity Fund?Most business property located in an Opportunity Zone will qualify. In fact, it might be easier to mention the property that doesn't qualify, which includes golf courses, country clubs, massage parlors, gambling facilities and stores that sell alcoholic beverages among others.
The use of the property must originate with the Fund, or the Fund can purchase existing property so long as the Fund "substantially improves" the property. In order to be a substantial improvement, the Fund must improve the property during the first 30 months of ownership by an amount equal to or in excess of the original cost basis. For example, if the Fund purchases land for $75,000, the Fund has 30 months to invest at least another $75,000, perhaps by constructing a building.
Where Do I Find an Opportunity Fund?In the near term, finding an Opportuity Fund will be your biggest challenge. The US Treasury has been slow to issue rules and guidance, so there are many unanswered questions. This has dampened the creation of Opportunity Funds, which can either be privately developed by an individual seeking to defer a capital gain from a current sale of property, or managed by an investment group for investors seeking a diversified portfolio of property holdings.
One such fund currently available is the Virtua Opportunity Zone Fund I, LLC. More info at:
Virtua Opportunity Zone Fund I
Please note, however, this is not an investment recommendation, but rather a resource to learm more about a Fund in action.
Where are Zones Located Close to You?To learn more about the location of the 126 Colorado and 628 Texas Opportunity Zones, the following link contains an interactive map to spot each Zone by county:
Interactive Opportunity Zone Map
Locally in Northern Colorado, the entire Estes Park area as well as pockets in Loveland and Fort Collins have been designated.
There are no tracts near the Katy, Texas areas of Harris, Fort Bend and Waller counties at this time. Most Zones in Harris County and Houston are in the central and southern areas of the county.
Opportunity Funds present a unique and market-driven investment approach to addressing the needs of low-income and underdeveloped communities throughout the US.
Be sure to let us know if you have questions or need additional information.