Below is an article from the REALTOR magazine, National Association of REALTORS, regarding the new Federal Opportunity Zone tax incentive for investors.
Get Up to Speed on O-Zones
A new tax incentive for investors could be a boon for sellers and struggling communities. But will affordability take a hit?
Editor’s note: This story has been updated with information about the proportion of Puerto Rico’s territory that is covered by the opportunity zone program.
When Daniel Zelonker, a South Florida broker who specializes in the sale of industrial buildings, looks for properties to recommend to clients, he confronts a challenge familiar to commercial real estate practitioners. While his clients often have a long time horizon for their investments, they want a solid return down the road in exchange for their patience—but the bite of taxes can stand in the way of achieving that goal. “They have income they don’t need today, and they want to see their funds grow,” says Zelonker, the owner of Z Miami Commercial Real Estate LLC. “I have to give them something [attractive] to do with their money.”
Real estate professionals like Zelonker have a new tool to help match clients with opportunities that suit their investment goals. A relatively unheralded section of the 2017 federal tax overhaul offers patient investors a deal that could be too good to turn down. The launch of the qualified opportunity zone program means that in return for rolling over the profits from the sale of a capital asset like real estate or company stock into certain economically disadvantaged areas, investors can delay paying capital gains taxes on those profits through 2026.
What’s more, if an investor retains an opportunity zone investment for at least five years, 10 percent of the initial investment is excluded from being taxed. After seven years, that figure increases to 15 percent. “This is being called the biggest tax break in our lifetime,” says Tiffany Lewis, a broker with Synergy Properties in Spokane, Wash., who focuses on working with residential property investors.
Opportunity zones are similar in some ways to 1031 like-kind exchanges, which permit real estate investors to defer taxes on gains from the sale of a property by reinvesting the proceeds from the sale in another property within six months. A key difference is that 1031s do not allow investors to permanently exclude any portion of their profit from taxes, which the opportunity zone program allows for investments held for at least 10 years.
Wide Investor Appeal
The promise of deferred taxes on capital gains and a potential tax-free profit down the road represents a powerful combination of incentives for investors at all levels—not only developers with large amounts of capital, says real estate attorney Adam Yormack, a partner at Escalante Yormack Law in Miami. “If you want to invest in and substantially improve a property, this is a huge opportunity. It’s changing the whole landscape,” says Yormack, who consulted with a variety of individual and institutional investors excited by the opportunity zone program. “The benefit is there for anybody who wants to invest in an up-and-coming neighborhood” that has an opportunity zone designation.
Investors do not need to live in an opportunity zone to invest in a fund that intends to invest in it. But it is critical to evaluate an area’s growth potential and the level to which it is already receiving or slated for public and private investments before deciding to invest money there. “You need to know the zoning laws and where the developable lots are,” says Lewis.
Teya Moore, principal broker with Benjamin and Banks Real Estate in Bowie, Md., says opportunity zones are particularly attractive to investors interested in commercial projects such as shopping centers and housing developments. “Investors are not usually interested in scattershot development that takes place house by house,” says Moore, who is also an attorney.
Lewis agrees. The requirement that opportunity funds dedicate a large portion of their investments to improving property they invest in means that fund managers are unlikely to be interested in acquiring individual homes unless they plan to demolish the property and replace it with a new commercial or residential project, she says. “It’s not that often that you buy a house for $100,000 and spend another $100,000 on renovating it.”
Yormack advises counseling clients who may be excited by the prospect of investing in an opportunity fund not to let the tax benefits cloud their judgment about whether the investment makes sense. “No one should be doing a deal if it doesn’t stand up on its own,” he says. Determining whether to invest in an opportunity zone should involve an examination of the factors that could impact the area’s future economic prospects, says Veronica Malolos, a broker with NAI Realvest in Orlando, Fla. These factors include zoning restrictions and the condition of public infrastructure such as roads and utilities. Investors should also take into account whether the local government is investing in services such as public safety and schools or plans to do so. “Opportunity funds are not for someone who doesn’t have the patience to do the research to be sure it’s truly an opportunity,” she says.
While opportunity zone investments can revitalize parts of the country that are behind the economic curve by attracting capital to areas that otherwise wouldn’t receive it, they can also pose negative consequences for communities, says Malolos, who serves as chairman of the county planning commission in Osceola County, Fla. Among her concerns is the possibility that existing residents of an opportunity zone find themselves unable to afford to stay as existing housing stock is displaced by newer and possibly more expensive inventory or redeveloped for nonresidential purposes, she says.
Read the IRS’ frequently asked questions about opportunity zones here.
“REALTORS® have to make sure we have a voice in reshaping our communities and making sure there is equal access for everybody,” says Malolos, who is also a former chair of the housing opportunities committee at the National Association of REALTORS®. “New development can mean that all of a sudden people have to move out, and the rich simply become richer.” Malolos hopes to counter this issue by taking an active role in developing public policies governing how areas she works in evolve.
A Boon for Residential Neighborhoods?
Residential specialists may find an opportunity zone designation to be a potent business development tool. That’s because homes in an opportunity zone, even difficult-to-sell homes, may become more marketable, drawing buyers who otherwise might not have paid attention. “Opportunity funds are scouring for properties,” Malolos says, “so if you’re listing a property in an opportunity zone, it presents an attractive benefit. I will add that information to the marketing materials.” Pointing out to homeowners that their property is in an opportunity zone might even help you find people who were thinking of selling and convince them to put their home on the market.
Despite these apparent marketing advantages, some are concerned about the designation of opportunity zones in areas that hardly need them in order to prosper. “While the definition of some of these census tracts suggests they are downtrodden, it’s not always true,” because a region can be economically vibrant despite what the statistics suggest, says Sheri Orlowitz, founding partner of Artemis Holding Group, an investment advisory firm in Washington, D.C., says.
The section of Queens in New York where e-commerce giant Amazon.com had intended to build a new headquarters, for instance, is labeled an opportunity zone yet is thriving, according to Orlowitz. The site is located in an area close to pockets of poverty. Amazon announced Feb. 14 that it had canceled its plans because of opposition from local lawmakers and the public.
An Attractive Proposition
Still, by and large, the OZ program is poised to transform communities across America that have been long been shunned by investors. The generous tax incentives that underpin the program make it possible for investors to come out ahead even if an investment yields a lower return than one in a more economically vibrant area might generate, says Brad Alexander, a senior adviser in the Atlanta office of McGuireWoods Consulting. “Opportunity zones are powerful tools that have a public purpose because they encourage investments in places that may [otherwise] be tough to invest in.
For more information regarding the new Oppertunity Zone (O-Zone) program please contact Ark Rhowmine. He can explain the basic difference between O-Zone investment and a 1031 Exchange.
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