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A Breakdown of the Opportunity Zones Program as the Deadline for Investment Nears

Interview with Alex Narcise and Stephanie Hughes

The Opportunity Zones program, created by the 2017 Tax Cuts and Jobs Act, offers private equity firms, family offices, and asset managers the chance to make an investment with up to 100% exemption of capital gains taxes. The deadline, however, is fast approaching: December 31, 2019. In this post, we’ll provide a breakdown of the program, as well as lay out the possible advantages and disadvantages of investment. Let’s dive in.

What Are Opportunity Zones?

Opportunity zones are economically distressed communities throughout the country that have been earmarked for new investments with the goal of stimulating economic growth and creating jobs. There are opportunity zones in all 50 states, the District of Columbia, and the five U.S. territories; see the U.S. Department of the Treasury’s Opportunity Zones Resources for a list and map of the zones.

How the Program Works

Taxpayers interested in reallocating capital from assets toward the improvement of struggling communities with the advantage of tax deferrals can do so through a Qualified Opportunity Fund (QOF). The capital gains remain tax-free until the QOF is divested or until the end of 2026, whichever comes first.

“In essence, the government is giving you a six-year interest-free loan on that money,” says Alex Narcise, Partner-in-Charge of Real Estate and Construction Services Group at Wiss & Company. What’s more, the benefits increase the longer you hold the investment. Investors who hold for five years get a 10% exclusion of the deferred gain, 15% for seven years. After holding for 10 years, the gain on the investor’s appreciation on the original investment is permanently excluded. While a 10-year holding period may feel perilous to some, others prefer to grow their investments over longer periods rather than turn them over early for possibly inferior returns.

As for making the actual investment, you have 180 days from the date of the sale or exchange of appreciated property to invest the capital gain in a QOF, which then invests in an opportunity zone property or business.

Who Should Consider Investment in a QOF?

According to Narcise, “Anyone who has a substantial capital gain and is seeking to defer tax payment,” is a good candidate for investment in a QOF. But there are other aspects to consider besides tax deferral. For one, the Opportunity Zones program was designed with a real-estate focus, which comes with its own set of pros and cons.

Real estate is generally considered a solid long-term asset class even in this, the longest bull market in history. We consider QOFs to be a safe option for long-term investments. However, thus far these funds have tended to focus on certain classifications of real estate, such as student housing or beachfront property, which may make the funds less attractive to those who like a diversified portfolio. Another deterrent may be the recent challenges within the retail industry, and developers’ resulting difficulty finding tenants for their properties.

But real estate isn’t the only avenue for investment through QOFs. “The other piece is that you can actually invest in a business that’s in an opportunity zone area,” says Stephanie Hughes, Chief Executive Officer of Wiss Family Office. “They say, ‘If you invest in our company, you get to defer your gain.’ So that’s an attractor for somebody to invest in a business in one of the opportunity zone areas.”

Best Practices for Seeking Out a QOF

So how does one actually find a QOF to invest in? “You could go to a developer,” Hughes says, “but chances are a developer is not going to accept money from an individual investor or would require a very high minimum investment.” Instead, she suggests working with a family or multifamily office, like Wiss, where they’ve done their homework on QOF offerings and understand the risks involved.

But taxpayers must do their own homework as well. “You want to look at the fund given it’s a liquidity,” Hughes advises. “You want to compare it to other illiquid private equity real estate funds. You want to look at the manager’s tenure; you want to look at the diversification of the assets in there.” All of this is to be sure you’re investing in something substantial and not being blinded by the allure of tax deferment.

Looking Ahead

As we move toward the 2020 U.S. presidential election, it’s important to consider the effect that the outcome could have on the Opportunity Zones program. For example, in the event of a Democratic victory, it’s possible that certain aspects of tax reform could be rolled back or that the capital gains tax rates could change, leaving investors with a net tax greater than if they had paid the capital gains tax at the 2019 rate.

Furthermore, if the economy is headed for a recession, as has been widely predicted, then there could be repercussions for the real estate market as well as for developers’ already hindered ability to find tenants to fill their properties.

For now, taxpayers must operate with the information available and weigh the risks as best they can before the end-of-year deadline comes to pass.

 

Disclaimer:
Wiss Private Client Advisors, LLC (“WPCA”) is an SEC-registered investment adviser with its principal place of business in New Jersey. WPCA provides individual client services only in states in which it is filed or where an exemption or exclusion from such filing exists. Registration with the SEC does not imply a certain level of skill or training.
The information contained herein should not be construed as the provision of personalized investment advice. We are neither your attorneys nor your accountants and no portion of this material should be interpreted by you as legal, accounting or tax advice. We recommend that you seek the advice of a qualified attorney and accountant.
Information contained herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Past performance is no guarantee of future results. Investing involves the risk of loss, including loss of principal invested, and may not be suitable for all investors.
Information contained herein includes certain forward-looking statements which indicate future possibilities. Actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that any views and opinions expressed in this presentation will come to pass. Additionally, information contained herein includes certain information derived from third party sources. Although we believe these sources to be reliable, we make no representations as to the accuracy of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.

alexander narcise, opportunity zone, pca, private client advisors, real estate, stephanie hughes

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