Everything You Need to Know About Investing in Opportunity Zones

The financial rulebook says that you should never depend on a single income, and that creating a second source by strategic investments is the answer to a secure life. But if investing was that easy, everyone would be a stock trader. 

Market volatility, risk tolerance, allocation of units, and finding the right time period to invest are some of the major challenges confronted when investing. Learning to deal with these, along with exploring unorthodox investment opportunities, can help strengthen an investor’s portfolio. Investing in the right opportunity zones is one such area. Here’s what you must know on the topic. 

What are the opportunity zones?

The opportunity zones are a part of a plan offered by the government to encourage people to capitalize more on areas that need improvement. Focused on economically weak neighborhoods, the opportunity zones provide access to several capital gains and tax incentives. In return, individuals can place potential investments in those communities. This is followed by a new asset termed as an opportunity fund. Unlike other initiatives of the government, the opportunity zones require precise certification and nomination. For instance, the mayor of Washington DC can nominate 25% of census selected on the basis of low-income requirements. Additionally, governors can also nominate 5% of the income tracts that meet other geographic perquisites. 

These requirements have been nominated by Internal Revenue Code section 45D (e). The main idea of creating opportunity zones is to help low-wealth communities foresee urbanization. The purpose also allows investors to potentially make gains with better returns. 

What are qualified opportunity funds?

If you are gearing up for this type of investment you will need to set up an organization or a partnership for opportunity zone properties. This investment is called Quality Opportunity Fund or QFA and holds 90% of the total assets of the property. 

The investment is prone to volatility in the opportunity zone fund. The entire purpose of the program is to enhance the quality of a particular area. This is achieved by expecting that the fund will continue to increase as the property improves when many investors set their eyes on it. For investors, a genuine amount of return starts generating when the property is urbanized or improved. The funds are then backed with the leases arriving from the third parties.  You can also use your income to support this type of investment.

The opportunity zone investment is a fairly new phenomenon and authorities are still working to perfect its functioning. Since it is a long tenure option, it is hard to assess the level of associated risks. The majority of the challenges include market loss, business risk, liquidity risk, and trend of real estate rates over time. 

What are qualified zone opportunity properties?

An asset that is turned into a kind of qualified opportunity zone stock, partnership, or business is termed as a qualified zone property. The property should have been acquired after December 31, 2017, and should have been used in business conducted in the opportunity zones. If you are using funds from an already owned property in the zone, it does not get counted as substantial improvement of the opportunity zone property. For development, you need to invest a sum equal to the initial investment of the fund that was used to buy the existing property. 

This might sound confusing. Here’s an example: If your opportunity zone fund acquires an existing property in the zone for $5 million, you will have to invest the same amount to improve the property. This means you will need an additional sum of $5 million that is used for the substantial enhancement of the property. This should be done within 30 days of grace provided. You can qualify for the program only after making these investments. 

Here, improvements should be made pertaining to the quality of life provided by the property to the community. Luxury amenities such as hot tub facilities, race tracks, gambling, liquor stores, country clubs, and golf courses do not count in improvement. 

Are there any specific rules and regulations?

To extract maximum potential benefits from opportunity zones, you need to adhere to the norms set by the government. This helps in understanding the investment prospects in qualified opportunity funds. Firstly, all of the investments should occur through QAF which can be a corporation or an association having the ability to certify itself. In case you are trying to earn through property investment, it should be improved as per the rules described in the QOF funds chart sheet. Also, the QOF shall hold 90% of your assets from the qualified opportunity zone. This measure is tested every six months to keep the investment intact. When it comes to earnings, the business initiated in the opportunity zone should earn a minimum of half of its income from the zonal activities. If you consider these regulations, you can easily foresee a genuine amount of return from your investment portfolio. 

What are the tax benefits in opportunity zones?

Usually taxes are paid when assets are sold in the form of real estate or stocks. There are various tax slabs for capital gains. But in the case of opportunity zones investment, the capital gains remain tax-free. This happens if you move the gains into the QFA (Qualified Opportunity Fund), within a time period of 6 months from the date of the sale of the asset. The taxes can be evaded until the year 2026. When you hold the returns from QFA for more than 5 years, a 10% exclusion is liable from the gain. When held for 7 years, an extra 5% is excluded, and if it is held for 10 years, it can be excluded from the taxation. 

To sum it up

Opportunity funds bring along a whole new compendium of different speculation options. Though opportunity zones investment might sound challenging at first, their relevance can be felt once your assets become stronger with the growth of the property. For people who do not refrain from treading in unknown waters, this can be an option worth exploring. Keeping a focused mindset and judging your options wisely may help in getting a fair start with such investments.  

Are you looking for ways to invest your money wisely? It might be a good idea to take the help of financial advisors before you begin your journey. They can help you devise out a strategic plan to get maximum benefits.