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What is the Opportunity Zones Program?
The Tax Cuts and Jobs Act of 2017 created a new tax incentive program to encourage capital investment in economically distressed areas of the country. Via the use of opportunity funds, corporations can attract investment into multifamily and commercial real estate, as well as stock or partnership interests in companies that operate in or do a significant amount of business in an Opportunity Zone.
- A Guide to the Opportunity Zones Program for Commercial and Multifamily Real Estate Investors
- Opportunity Funds Hope To Tap A $6.1 Trillion Market
- How Opportunity Funds Work
- The Opportunity Zone Creation Process
- Opportunity Zones and the Low-Income Housing Tax Credit (LIHTC) Program
- Financing Multifamily Properties in Opportunity Zones
- Related Questions
- Get Financing
A Guide to the Opportunity Zones Program for Commercial and Multifamily Real Estate Investors
The Tax Cuts and Jobs Act of 2017 ushered in a variety of changes to the way corporations are taxed, but it also created a new tax incentive program to encourage capital investment in economically distressed areas of the U.S. Via the use of opportunity funds, corporations can attract investment into multifamily and commercial real estate, as well as stock or partnership interests in companies that operate in or do a significant amount of business in an Opportunity Zone.
However, in order to qualify for the tax incentives offered by the Opportunity Zones program, investors must invest through an Opportunity Fund. When investing in real estate, an Opportunity Fund must either invest in new construction or substantial rehabilitation of properties, to ensure the funds are actually being used to improve the area in question. In the case of building improvements, an Opportunity Fund needs to invest more in a building’s rehabilitation than it originally invested in the building’s purchase. In either scenario, all construction and rehabilitation work must be completed within 30 months of a property’s purchase.
Opportunity Funds Hope To Tap A $6.1 Trillion Market
A 2017 analysis estimated that U.S. households and corporations are sitting on $6.1 trillion of unrealized capital gains in stocks and funds. In general, both individual investors and corporations would not want to sell any of these assets to re-invest them, as they would be required to pay capital gains taxes. By instead re-investing these funds into low-income areas, they can help revitalize low-income areas across the U.S. Unlike the Low-Income Housing Tax Credit (LIHTC) program, which is limited to a specific amount each year, Opportunity Zones are actually written into new IRS regulations, meaning there is no limit to the tax incentives which investors can claim under the program.
How Opportunity Funds Work
As we mentioned previously, investors must invest through an Opportunity Fund in order to qualify for the tax incentives offered by the Opportunity Zones program. An Opportunity Fund is a partnership or corporation which plans to invest a minimum 90% of its assets in Opportunity Zones. Opportunity funds permit investors to avoid paying taxes on recent capital gains until December 31, 2026.
If an investor keeps their money in an Opportunity Fund for at least 5 years prior to December 31, 2026, they will reduce their deferred capital gains tax liability by 10%, while if they keep funds in for seven years before that date, they can reduce their tax bill by 15%.
In some cases, investors may even reduce their tax liability to zero on any profits they generated by investing in an Opportunity Fund, though they will need to hold their investment in the fund for at least 10 years in order to qualify. In addition, it’s important to realize that Opportunity Funds can self-certify, meaning that they do not specifically need to be approved by the government.
The Opportunity Zone Creation Process
After the Tax Cuts and Jobs Act was passed in 2017, the governors of U.S. states and territories (and the mayor of Washington, DC) were allowed until April 2018 to nominate census tracts to become Opportunity Zones. In order to be eligible to become an Opportunity Zone, an area needs to meet IRS income requirements, including:
A minimum poverty rate of 20%
A median family income of:
Non-metropolitan areas: Less than or equal to 80% of the statewide median family income
Metropolitan areas: Less than or equal to 80% of the statewide median family income or the overall metropolitan median family income (whichever is greater)
Caliber Tax Advantaged Opportunity Zone Fund, LP: Planning to deploy $500 million of capital in Arizona, Colorado, Nevada, Texas, and Utah, Caliber’s fund focuses on affordable housing, commercial real estate, hospitality development, mixed-use development, multifamily and single-family residential, and student housing.
Allagash Opportunity Zone CRE Fund I: With plans to deploy $500 million of capital in Virginia, North Carolina, and Maryland, the Allagash Fund focuses its investments in commercial real estate, workforce housing, affordable housing and multifamily residential housing.
Cresset-Diversified QOZ Fund: Looking to generate $500 million of capital commitments, Cresset’s fund plans to invest in all 50 states, in asset groups including low-income housing, self-storage, parking, and even relocating existing businesses into Qualified Opportunity Zones.
EJF OpZone Fund I LP: Managed by EJF Capital, EJF OpZone Fund I LP also plans to raise $500 million of capital nationwide to focus on investments in the affordable housing, mixed-use development, commercial real estate, workforce housing, student housing, and multifamily residential sectors.
EquityMultiple Opportunity Zone Fund: Much like the EJF OpZone Fund I LP, EquityMultiple’s Opportunity Zone Fund is attempting to raise $500 million of capital nationwide to invest in commercial real estate, multifamily residential properties, affordable housing, workforce housing development, mixed-use development, and student housing.
What are the benefits of investing in Opportunity Zones?
The benefits of investing in Opportunity Zones include deferring capital gains taxes until the investment is sold or by December 31, 2026, whichever occurs first. Additionally, investors who keep their money in an Opportunity Fund for at least 5 years will receive a 10% reduction of their capital gains tax liability, while those who keep their investment in the fund for at least 7 years will receive an additional 5% discount, for a total 15% capital gains tax discount. Lastly, investors who keep their money in an Opportunity Fund for at least 10 years will not have to pay any capital gains taxes on any additional appreciation their investment has experienced since it was placed in the fund.
Source: Commercial Real Estate Loans and Multifamily Loans
What are the requirements for investing in Opportunity Zones?
In general, most experts believe that it’s not worth investing in an Opportunity Fund unless you have a minimum 10-year investment horizon. This way you can take full advantage of all of the tax benefits of Opportunity Fund investing. Therefore, if an investor is elderly, in poor health, or may need to use their funds within a few years, investing in an Opportunity Fund may not be the best choice. For commercial or multifamily real estate investors who wish to start their own Opportunity Fund, it’s generally recommended that they have at least $1 million in assets to invest. Otherwise, the operational and administrative costs of opening a fund may negate the potential tax benefits.
To be eligible, a property must either be new construction, or if it is a rehabilitation project, the Opportunity Fund must invest equal or greater funds into property improvements than it did to initially purchase the property. However, a recent regulatory ruling posits that this only applies to the cost of the building, not the cost of the land. For instance, if an Opportunity Fund invested $1 million into an outdated apartment building, and it was found that the building was worth $600,000, while the land was worth $400,000, the Opportunity Fund would only need to invest $600,000 into property improvements, not the full $1 million. In addition, all construction or rehabilitation projects must be completed within 30 months.
For an Opportunity Fund to invest in a business, the business must not be in a prohibited category. Prohibited business categories include liquor stores, massage parlors, gambling-related businesses, golf courses, tanning salons, and several other types of “sin” businesses. Despite this, an Opportunity Fund can generally own property that is being leased to these businesses, they just cannot own shares in these types of businesses themselves. Plus, the business must do at least 70% of its business inside the Opportunity Zone in order to qualify.
U.S. Department of the Treasury will conduct an asset test twice annually to ensure compliance. Funds who do not meet the asset test will be levied a variable fee (currently set at 6% per year) until they reach compliance.
What types of investments qualify for Opportunity Zones?
To qualify for the Opportunity Zones program, investments must be made in eligible properties and businesses located in specific, economically disadvantaged census tracts across the country, referred to as Qualified Opportunity Zones (QOZs). There are currently 8,700 of these Qualified Opportunity Zones (QOZs) across the country. To gain the tax benefits of the Opportunity Zones program, an investor must invest in an Opportunity Fund, a special investment vehicle which needs to hold at least 90% of its assets in eligible property or businesses located inside an Opportunity Zone.
To be eligible, a property must either be new construction, or if it is a rehabilitation project, the Opportunity Fund must invest equal or greater funds into property improvements than it did to initially purchase the property. However, a recent regulatory ruling posits that this only applies to the cost of the building, not the cost of the land. For instance, if an Opportunity Fund invested $1 million into an outdated apartment building, and it was found that the building was worth $600,000, while the land was worth $400,000, the Opportunity Fund would only need to invest $600,000 into property improvements, not the full $1 million. In addition, all construction or rehabilitation projects must be completed within 30 months.
For an Opportunity Fund to invest in a business, the business must not be in a prohibited category. Prohibited business categories include liquor stores, massage parlors, gambling-related businesses, golf courses, tanning salons, and several other types of “sin” businesses. Despite this, an Opportunity Fund can generally own property that is being leased to these businesses, they just cannot own shares in these types of businesses themselves. Plus, the business must do at least 70% of its business inside the Opportunity Zone in order to qualify. This rule has caused serious concern for many Opportunity Funds, and is part of the reason why most initial O-Zone investments have gone toward commercial and multifamily real estate, not businesses.
How do Opportunity Zones work?
The Opportunity Zones program is a tax incentive program designed to encourage investment in low-income communities. Investors must invest through an Opportunity Fund in order to qualify for the tax incentives offered by the Opportunity Zones program. An Opportunity Fund is a partnership or corporation which plans to invest a minimum 90% of its assets in Opportunity Zones. Opportunity funds permit investors to avoid paying taxes on recent capital gains until December 31, 2026.
If an investor keeps their money in an Opportunity Fund for at least 5 years prior to December 31, 2026, they will reduce their deferred capital gains tax liability by 10%, while if they keep funds in for seven years before that date, they can reduce their tax bill by 15%. In some cases, investors may even reduce their tax liability to zero on any profits they generated by investing in an Opportunity Fund, though they will need to hold their investment in the fund for at least 10 years in order to qualify.
To be eligible, a property must either be new construction, or if it is a rehabilitation project, the Opportunity Fund must invest equal or greater funds into property improvements than it did to initially purchase the property. However, a recent regulatory ruling posits that this only applies to the cost of the building, not the cost of the land. For instance, if an Opportunity Fund invested $1 million into an outdated apartment building, and it was found that the building was worth $600,000, while the land was worth $400,000, the Opportunity Fund would only need to invest $600,000 into property improvements, not the full $1 million. In addition, all construction or rehabilitation projects must be completed within 30 months.
For an Opportunity Fund to invest in a business, the business must not be in a prohibited category. Prohibited business categories include liquor stores, massage parlors, gambling-related businesses, golf courses, tanning salons, and several other types of “sin” businesses. Despite this, an Opportunity Fund can generally own property that is being leased to these businesses, they just cannot own shares in these types of businesses themselves. Plus, the business must do at least 70% of its business inside the Opportunity Zone in order to qualify.
What are the tax incentives for investing in Opportunity Zones?
Investors who invest in an Opportunity Fund may qualify for three main tax incentives. If they invest assets in an Opportunity Fund within 180 days of their sale, investors may defer capital gains taxes until they sell their investment or by December 31, 2026, whichever occurs first. In addition, investors who keep their money in an Opportunity Fund for at least 5 years will receive a 10% reduction of their capital gains tax liability, while those who keep their investment in the fund for at least 7 years will receive an additional 5% discount, for a total 15% capital gains tax discount. Lastly, investors who keep their money in an Opportunity Fund for at least 10 years will not have to pay any capital gains taxes on any additional appreciation their investment has experienced since it was placed in the fund. Source 1 and Source 2.
What are the risks associated with investing in Opportunity Zones?
The main risk associated with investing in Opportunity Zones is that the investor may not be able to take full advantage of the tax benefits if they need to use their funds within a few years. According to Commercial Real Estate Loans, it's generally recommended that investors have a minimum 10-year investment horizon in order to take full advantage of the tax benefits. Additionally, investors who wish to start their own Opportunity Fund should have at least $1 million in assets to invest, as the operational and administrative costs of opening a fund may negate the potential tax benefits.
- A Guide to the Opportunity Zones Program for Commercial and Multifamily Real Estate Investors
- Opportunity Funds Hope To Tap A $6.1 Trillion Market
- How Opportunity Funds Work
- The Opportunity Zone Creation Process
- Opportunity Zones and the Low-Income Housing Tax Credit (LIHTC) Program
- Financing Multifamily Properties in Opportunity Zones
- Related Questions
- Get Financing
No more than 25% of census tracts in each of these qualified areas can be nominated. Another 5% of the census tracts in a qualifying area may also be eligible, given that they adjoin a current Opportunity Zone, and that the median family income in the area is not more than 125% of the median family income in the adjoining Opportunity Zone.
As a result of this nomination process, approximately 12% of the census tracts in the U.S. are now Opportunity Zones, which adds up to approximately 8,700 census tracts around the U.S.
The Largest Opportunity Funds
Right now, there are quite a few large Opportunity Funds on the market, each of which invests in a slightly different group of assets. Some of the largest include:
Opportunity Zones and the Low-Income Housing Tax Credit (LIHTC) Program
Earlier, we mentioned the differences between the Opportunity Zones and LIHTC tax incentive programs, and, while these programs are different, they may also be able to be combined for an even greater tax benefit. However, in practice, LIHTC and Opportunity Fund investors are often very different in nature; LIHTC investors are often banks, which cannot own equity investments— and therefore do not generate any capital gains that can be offset by the Opportunity Zones tax incentive. However, for high net worth individuals and certain investing partnerships, combining these two programs could be highly effective. In general, though, this will have to result from new construction, as it’s unlikely that an LIHTC property rehab would cost more than the price of acquiring the property in the first place (as is required for the Opportunity Zones program).
Investors looking to fund LIHTC properties in Opportunity Zones may also benefit from utilizing HUD multifamily loans, such as the HUD 221(d)(4) loan for the construction and substantial rehabilitation of multifamily properties. HUD multifamily loans offer between 87-90% LTV for affordable properties and a reduced mortgage insurance premium (MIP) of 0.45% (as opposed to 0.65% for market-rate projects). Plus, the HUD 221(d)(4) loan offers a fixed rate 40-year loan term (with an additional 3-year construction period).
For eligible properties, LIHTCs and Opportunity Zone tax credits can also be combined with rental assistance demonstration (RAD) properties — though this is only likely to occur in limited circumstances— such as in RAD demolition and reconstruction projects, which are only a small percentage of all RAD conversions.
Financing Multifamily Properties in Opportunity Zones
While we just mentioned HUD multifamily financing, it’s far from the only way to finance multifamily properties in Opportunity Zones. Other common multifamily loan options include Freddie® Mac® and Fannie® Mae® Multifamily financing, however, Fannie and Freddie do not offer ground-up construction loans; only property rehabilitation loans and refinancing. For ground up construction, many investors/developers may wish to obtain a short-term bank construction loan, and then refinance into longer-term fixed-rate financing such as a 5-7 year CMBS loan or a Fannie Mae® or Freddie Mac® multifamily mortgage. They may also want to refinance with a HUD multifamily loan, such as the HUD 223(f) loan for property acquisitions and refinances.