Understanding Opportunity Zones

What Are Opportunity Zones?

Opportunity Zones are federally-recognized areas in economically distressed communities, defined by their census tracts, that offer preferential tax treatment for new investments. These areas are characterized by high poverty rates, low median family income, and high unemployment.

The Opportunity Zone program aims to encourage long-term investment in low-income communities by providing tax incentives for investors. Since its inception in 2017, the program has grown to include 8,769 Opportunity Zones across all 50 states, Washington, D.C., and five U.S. territories.

What Are Opportunity Funds?

An opportunity fund is a privately managed investment vehicle, organized as a corporation or partnership, with the specific purpose of investing in a qualified opportunity zone property. The fund must hold at least 90% of its assets in opportunity zones.

Keep in mind that in order to qualify for the new tax incentives, you must invest through a qualified opportunity fund. You cannot invest your capital gains directly in an opportunity zone business or property and still qualify for the incentives.

Opportunity Zone Tax Benefits

• Capital gains tax deferral
• 10% exclusion of taxable gains from the original investment amount if held for at least 5 years
• 15% exclusion of taxable gains from the original investment amount if held for at least 7 years
• 15% exclusion of taxable gains from the original investment amount and 100% exclusion of Opportunity Fund investment gains if held for at least 10 years
• Potential for greater returns than traditional stock portfolios with long-term holding periods

By investing in an opportunity fund, you can enjoy capital gains tax deferral, reduction, or even permanent exclusion. While you can choose to temporarily defer inclusion in taxable income for capital gains reinvested in an opportunity fund until you dispose of the investment (on or before December 31, 2026), there are greater rewards for holding on to the investment.

For starters, if you retain the investment for at least five years, you can exclude 10% of the taxable gains from the original investment amount.

If you retain the investment for at least seven years, you can exclude 15% of the taxable gains from the original investment amount.

If you retain the investment for at least 10 years, you can exclude 15% of the taxable gains from the original investment amount and 100% of the taxable gains of the opportunity fund investment.

The longer you hold on to the opportunity zone investment, the greater the reward. According to the Economic Innovation Group, if you reinvested a capital gain of $100 in an opportunity fund in 2018, by 2028 you would have $44 more than if you had invested that money in a traditional stock portfolio.

In other words, this opportunity is for patient investors. If you have capital gains and some time, an opportunity fund can be a worthwhile investment.

But is the program beneficial for communities as well?

The Benefits of Opportunity Zones for Communities

Proponents of the program hope it can undo some of the damage of the last century of “urban renewal," which some believe contributed to disproportionate or misinformed development. New investments can help rebuild essential needs for a poorly developed community, boosting its economy and employment opportunities.

Plus, less government oversight for these investments means that innovators in a variety of industries can use the tax incentives to be responsive to the needs of various communities. They sometimes choose to invest directly in businesses or properties to help support their projects.

Why Some Are Skeptical of Opportunity Zones

Detractors, however, fear that the lack of oversight will lead to minimal improvement at street level.

Currently, the legislation does not define specific outcomes to help determine whether the investments have lead to real change.

It also does not include a requirement for economic metrics or data reporting.

How to Invest Wisely in Opportunity Zones

The key to ensuring your investment is beneficial to the community as well as your portfolio is to consult stakeholders in the area.

If you're investing in Alabama, for example, contact Opportunity Alabama (OPAL) a nonprofit initiative dedicated to connecting investors with opportunities in one of the state's 158 opportunity zones.

Or in the case of a more specific city, Invest Atlanta, for instance, has created its own investor registry to oversee local opportunity zone plays, keeping track of the types of projects that interest investors and helping them connect with businesses.

To find out more about investments in other areas, review these state-by-state Opportunity Zone resources.

Closing Thoughts

Opportunity zones offer a unique opportunity for investors to make a positive impact on their communities while also benefiting from tax incentives. By understanding how opportunity zones work and investing wisely, individuals can help revitalize low-income areas and create jobs. Whether you're an individual investor or a business looking to make a difference, opportunity zones are an innovative way to drive economic growth and community development.

This article was updated on 10/10/2024