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A fresh look at opportunity zone benefits

Jan 12, 2023

The tax benefits of opportunity zones used to be a popular topic in real estate. There were thousands of webinars, in-person conferences and content pushed out to help people understand the tax benefits.

People were propagating themselves as opportunity zone tax benefit experts even before there were regulations. Often, states were asked to declare opportunity zones without fully understanding the impact of what that meant for both the state and the investors.

Now that the program has been operating for several years, has the excitement over opportunity zone tax benefits really died, or have opportunity zones merely become what they were always meant to be?

If you want to determine whether opportunity zone tax benefits are still relevant to you, consider the deals available, tax implications and future bills.

Potential for real estate deals

While no exact data exists to determine how many real estate projects there are compared to a true operating business, most anecdotal data suggests that the primary use of opportunity zone funds have been heavily real estate focused. And opportunity zone designations have received a fair amount of criticism accordingly.

Common concerns are that states, intentionally or otherwise, have picked affluent areas or areas no one would develop. Given that, merely executing a development because it is in an opportunity zone is not recommended.

Instead, take time to assess whether the deal is inherently a good project before you consider the addition of opportunity zone benefits.

If you do determine it’s a good project, you still need to ensure that it makes sense within the opportunity zone rules. There are many questions to ask yourself beforehand, including: Will the new project require a triple net lease? Do you plan to hold the project for 10 years or complete a short-term flip?

Those kinds of questions will help you determine whether a project is suited for an opportunity zone structure.

Opportunity zone tax implications

Under current law, there are still two tax advantages of opportunity zones.

  1. The ability to defer the capital gain that you are investing in funds until December 31, 2026.
  2. After you’ve held the fund for 10 years, when the asset is sold, you will get a step-up to fair market value, eliminating the gain.

People often take advantage of the short-term deferral without considering whether the deal makes sense for the long term.

During the last two years, many deals have unwound, with taxpayers stuck paying tax not only on the qualified opportunity zone asset they sold but also the inclusion event of their originally deferred gain.

To avoid this, it’s important not to rush into a project merely for the deferral period. You have to analyze the costs of putting together the opportunity zone deal if it were to be cut short of 10 years.

Another important consideration is whether investing in opportunity zones makes sense because of the potential change in capital gain tax rates.

Opportunity zones allow a deferral of the gain and not the tax itself.

Thus, a 20% capital gain tax rate could be higher in 2026. However, for the long term, you need to analyze whether you’d still have the benefit of holding the deal for 10 years and eliminating the appreciation on that as well.

Future legislation

On the legislative front, there is still traction to keep opportunity zone tax benefits relevant. Currently, there is the Opportunity Zone Improvement, Transparency and Extension Act, introduced by several senators and House representatives. This bill aims to do the following:

  • Increase reporting requirements for opportunity zones that were initially intended as part of the rules
  • Extend opportunity zone investing until 2028
  • Extend the basis step-up of originally deferred gain due to the 2028 extension
  • Sunset opportunity zone tracts where the median family income is at or above 130% of the national family income
  • Allow fund-to-fund investments for qualified opportunity funds

Compared to the beginning of the program, investors are now more educated on the opportunity zones and tax benefits, making more diligent decisions and looking for more legislative support.

Overall, opportunity zone tax benefits are still as relevant as they once were. But the benefits you can gain depends on the deals you make and whether your projects will produce the desired results.

How Wipfli can help

At Wipfli, our real estate team keeps pace with changing regulations so that we’re always ready to help you take full advantage of opportunity zone tax benefits. We’ll guide you through the setup and structuring of your qualified opportunity fund so that your investments can do more.

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Author(s)

Dannielle Lewis, CPA
Partner
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