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Who doesn’t love tax-free money? I know I do! If you are looking for an investment vehicle that has great tax advantages, look no further. The creation of Opportunity Zones is one of the greatest ways to generate wealth and shelter your income from taxes ever created. In this article, I will explain what an Opportunity Zone Fund is and how it works. I will break down some of the details so you can decide if it’s a good investment opportunity for your current financial situation.
What is an Opportunity Zone?
The Opportunity Zone investment vehicle was created by the Tax Cuts and Jobs Act (passed on December 22, 2017). An Opportunity Zone is an economically-distressed community where new investments may be eligible for preferential tax treatment.
Essentially, the government wants people, like you, to invest in low-income areas. The government uses tax-incentives to push its social agenda. The goal is to get people to save money, reinvest it, and rebuild dilapidated communities.
Moreover, the Opportunity Zone is a tool which spurs economic development by providing tax benefits to investors who rebuild and create jobs in distressed communities.
In total, there are 8,700 qualified Opportunity Zone tracts in the US and within its territories.
What Tax Benefits Do Opportunity Zones Provide?
Investors can defer taxes on any prior gains when they roll the invested amount into a Qualified Opportunity Fund (QOF). If you hold on to a property within a QOF for 10 years, you will receive a step-up in value.
This means that the cost basis will become equal to its fair market value on the date that the qualified opportunity fund investment is sold or exchanged. You can learn about how a step-up in value works by reading How to Defer Taxes Forever with a 1031 Exchange.
Therefore, if you sell a property after owning it for 10 years within a QOF, you won’t owe any taxes!!!
Should you decide to sell the property before the 10-year mark:
- If the investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain
- more than 7 years, the 10% becomes 15%
What Qualifies as Eligible Capital Gains for Investment into an Opportunity Zone?
Capital Gains coming from any of the following investments can be contributed to an Opportunity Zone Fund and receive tax-benefits:
- The sale of stocks or bonds
- Income from the sale of a property
- The sale of an interest in a partnership
An added benefit is that you and other investors can pool funds to invest in multiple assets.
Where Are These Opportunity Zones Located?
The U.S. Treasury Secretary certifies certain zones that qualify for Opportunity Zone investment. For an area to qualify, the poverty rate must be > 20%. In fact, many of the zones have an average poverty rate of nearly 31%.
A list of Opportunity Zones can be found on the US Department of the Treasury’s website (CDFI Fund page).
Here is a quick visual of where Opportunity Zones can be found.
Photo credit: impactalpha.com
In order to qualify, the fund must intend to engage in ground-up development. Meaning that you have to “substantially improve” an existing property.
Equity over Debt: Capital gains that are invested in a Qualified Opportunity Fund must be equity and not debt. What this means is that you cannot use loans or leverage.
Additionally, you will need to invest your capital gains into a Qualified Opportunity Fund within 180 days of realizing your capital gains from a prior investment. Remember to coordinate with your accountant because you are solely responsible for ensuring your eligibility.
How to Tackle Low-Income Tenant Problems Before they Occur:
One cautionary mention is that you should be familiar with how to rehab properties (work with contractors) and manage rental properties. One way to reduce late or missed rent payments is to become a section 8 landlord.
Section 8 tenants get assistance from the government, meaning that a portion of their rent will always get paid. What’s more, is that if a tenant fails to pay their rent on time or is consistently late on payments it will jeopardize their status to continue to receive a Section 8 voucher.
Here is a quick video provided by Shelter Press on how to become a Section 8 landlord.
The Take Away:
Diversification is one of the most important aspects when deciding how to allocate your investment portfolio. Spreading out your risk amongst many different asset classes will help you weather the many inevitable storms to come. Your investment portfolio should include stocks, ETFs, fixed income assets, real estate, and other investment vehicles.
To learn more about Ray Dalio’s All Season’s stock portfolio, read Stocks: A Diversified Portfolio.
Want to know more about the 1031 exchange and how to create your own opportunity zone fund?
The Increase Your Financial IQ Course will take a deeper dive and explain these and other wealth building strategies in more detail. For now, sign up for the FREE Increase Your Financial IQ Email Course for more information on financial planning and wealth creation!
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Like what you see? Stay a while!
- How to Defer Taxes Forever with a 1031 Exchange
- Tax-Free Money: The Secret of Buying Gold Inside of a Roth IRA
- How to Save for a Down Payment on a Home and Fund a Roth IRA
- Increase the Velocity at Which Your Money Grows: Ways to Save
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