Opportunity zones expand the number of potential real estate investments by opening up the possibility for greater profits on long-term plays in economically challenged areas. The Tax Cuts and Jobs Act provision could lead to a win-win for developers/investors and countless economic development programs across the country, according to experts from Kidder Mathews, the largest independent commercial real estate firm on the West Coast.
“It sounds too good to be true, but the biggest advantage is the permanent exclusion from taxable income of capital gains from the sale of an investment in a qualified opportunity zone fund as long as the investment is held for at least 10 years,” said Mike King, VP of investments for Kidder Mathews in Seattle.
Real estate investment always involves risk, which tends to increase in areas that have fallen behind in economic—and property value—growth. Prior to the Opportunity Zone legislation, there was little incentive to invest in this type of real estate. That can change in a hurry when investors are allowed to defer and even lower overall taxes on capital gains earned by the sale of Opportunity Zone properties.
Under the economic development measure designed for distressed communities, any real estate investment held less than five years is eligible for deferment of capital gains taxes, so long as the gains are reinvested into an Opportunity Zone. Investments held more than five years are eligible for overall capital gain tax reductions of 10 to 15 percent.
“Furthermore, investments held for 10 years or longer can elect to retroactively increase the basis of the investment to the fair market value on the sale date, which allows for even more tax savings,” said Robert Thornburgh, EVP of Brokerage for the Greater Los Angeles region. “In short, what this does is increase the supply of real estate that is attractive for long-term investment.”
Not all parcels will derive a value benefit from an Opportunity Zone, which only offers capital gains tax deferral through the end of 2026. According to Eric Thies, SVP of investment sales for Kidder Mathews in San Diego, properties must respond to the two primary demand drivers created by the legislation: the increased flow of funds into otherwise feasible development projects and the repositioning of properties that can accommodate the migration and creation of qualified Opportunity Zone businesses. Thies notes NNN investors may see the biggest winners.
The Economic Innovation Group reported that the country’s Opportunity Zones already contain 24 million jobs and 1.6 million businesses. Also, 75 percent of the zones are located in zip codes that saw at least some level of post-recession job growth from 2011 to 2015.
Too good to be true, indeed. But as Thies notes, “Key provisions of the code are yet to be clarified—which may impose risk.”