Authored by Kevin J. Bray:
If you are in the process of selling a large amount of RSU’s or a business and expect a large capital gain, there are some new creative tax planning strategies you can take advantage of. One of which is doing a NON-LIKE-KIND EXCHANGE of proceeds into a Qualified Opportunity Fund that invests in real estate Opportunity Zones. If you don’t have this tax planning strategy on your radar, you are possibly missing out on a great tax planning opportunity. In my opinion, this is one of the biggest deals in the new tax law passed at the end of 2017 and effective for 2018 tax returns. This article includes a brief overview of Opportunity Zones and Qualified Opportunity Funds. I am not advocating for any of the investments listed below. I recommend consulting with your CPA and/or financial advisor to see if you are a candidate for this type of investment and tax planning strategy.
“An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.”
These zones were created all across the country in every state. Each state has their own database to search within these zones. I recommend working with an experienced real estate broker to navigate this landscape because it’s easy to get lost in the data available. I’m not sure how the government determines which areas are considered “Opportunity Zones,” but as you can see in the image below in green, some of these zones are right in the middle of fast-growing cities, like Seattle.
When you invest proceeds from the sale or exchange of a capital asset (i.e. gains from portfolio transactions; gains from selling real estate) into one of these zones or a fund that invests in these zones, you can defer paying the taxes on the gain until 2026 and if you hold the new Opportunity Zone investment for a minimum of 7 years, you get a free 15% step-up on the basis in the asset you sold (which means you don’t have to pay tax on 15% of the capital gain you deferred!), provided you make the election prior to December 31, 2019. You still have to pay taxes on the original gain, but if you hold the real estate or QOF for at least 10 years you get the remainder of the realized gain tax-free. More information on the timeline here:
Here is a snippet from the IRS’s website: “Opportunity Zones are designed to spur economic development by providing tax benefits to investors. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.”
Real estate tends to appreciate over long periods of time near urban hubs, especially if you are investing in submarkets that will benefit from expansion in nearby cities within an hour’s commute. Cities that have diverse economies and fast-growing tech companies- Seattle, San Francisco Bay Area and Austin come to mind. If you look at the map of Opportunity Zones there are plenty around these areas that will likely see growth over the next 10-20 years as tech continues to drive the local economies.
If you want to control the asset(s) yourself there are a few more hoops you have to jump through to create your own Qualified Opportunity Fund, like filing IRS Form 8996 and keeping detailed accounting records. Personally, I’d rather control the purchase, rehab and management of the real estate. Reonomy is a good tool to use to search for properties that fall inside of opportunity zones, but it’s not cheap and may only make sense for professional ownership groups, brokers and developers to subscribe to. The major commercial real estate brokerage firms like Colliers International, CBRE and JLL are likely utilizing the tool. I recommend reaching out to your local brokerage for information.
If you don’t have the time resource to dedicate to a side investment venture like this, you can put your money in a Qualified Opportunity Fund. Lots of groups are trying to form them ASAP. Grubb Properties has a detailed pitchbook describing their approach (More info in links provided at the bottom of this article). Fundrise is also in the process of organizing a fund that will target properties in LA, Oakland, Seattle and San Diego. Do your due diligence and research each company’s track record! I would not trust my hard-earned cash with just any firm. I am not advocating for these specific funds. I am providing them as an example of what is out there.
If you have any questions about the tax side of investing in an Opportunity Zone or Qualified Opportunity Fund, please don’t hesitate to reach out to our affiliate CPA firm, Benton Bray PLLC. Brian Bray or Tyler Opp will be able to assist you.
Source Document Links & Additional Information:
Kevin manages marketing, business development, and customer success for Dental Accounting Professionals LLC & Benton Bray PLLC. He is highly analytical, creative, and forward thinking in his approach to working with clients. His background is in commercial real estate with a focus in dental office leasing and investment sales. Kevin’s passionate about investing for the future and implementing new technologies to streamline outdated workflow processes to increase bottom line results.