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Offering significant tax breaks for investors, the federal
Qualified Opportunity Zone (QOZ) program is an intriguing
prospect for real estate developers and investors. However,
the Treasury Department is still formalizing the rules for these
investments, creating a dilemma: buy now and save big on
capital gains taxes, or wait to avoid unknown pitfalls?
The QOZ program was included by Congress in the Tax Cuts
and Jobs Act of 2017 as an economic development tool to
encourage investment in low-income urban and rural districts
through a Qualified Opportunity Fund (QOF) with the goal of
revitalizing troubled areas by spurring business development
and creating jobs. Investors have a wide range of acceptable
investments to choose from—everything from rehabilitation of
existing structures, new construction, and startups.
As intriguing as the program is, how do you know if an
investment is worth considering? Here are some pros and cons
of investing in a QOZ.
THE PROS
Deferred and Reduced Taxes
The program allows investors to defer taxes on income
from capital gains until December 31, 2026, if their
capital gains are invested in a QOF within 180 days of
realizing the gain. Taxes are discounted 10% after a
five-year holding period, and an additional 5% at seven
years if held for the applicable period until December
31, 2026. If the investor holds the investment for 10
years, there is no tax on the appreciation of the value
of the investment when the interest in the QOF is sold.
THE CONS
The clock is ticking.
Because the deferral of capital gain lasts only through
December 31, 2026, (or the sale of the interest in the
QOF, if earlier), the value of the deferral goes down
every day. This is also the last year investments will be
able to meet the 7 year holding period to qualify for
the full 15% exclusion of capital gains from taxation.
There are currently many
unknowns in the regulations.
Rules for rehabilitation projects are fairly clear: you
must double your adjusted basis in any buildings on
the property over 30 months. The rules for vacant
land or projects involving the demolition of existing
buildings are unclear.
There are requirements that call into question the
ability of multifamily housing and triple net leases to
qualify for the intended tax benefits. Those issues are
expected to be clarified in future regulations.
Further guidance is needed concerning the ability of
QOFs to dispose of assets and reinvest the proceeds
in additional opportunity zone investments.
Certain businesses are excluded
from the tax benefits, including
golf courses, liquor stores,
massage parlors, country clubs,
hot tub facilities, suntan facilities,
and racetracks.