Opportunity Zone Funds: Pros And Cons

In the U.S. in exchange for investing Opportunity Zones, investors can access capital gains tax incentives available only through these zones. There are a number of pros and cons when investing in these funds.

A qualified Opportunity Fund is a U.S. partnership or corporation that intends to invest at least 90% of its holdings in one or more qualified Opportunity Zones.

Who Qualifies?

Anyone can invest, said Bill Smith, managing director for CBIZ MHM's National Tax Office in Bethesda, Maryland.

The only types of income that qualify for the benefits are capital gains realized and reinvested in Qualified Opportunity Zone funds within 180 days, with a possible extension for individual investors in pass-through entities, he said.

Opportunity Zones were created to stimulate investment in economically depressed areas. States nominated areas that were then certified by the Treasury. There are more than 8,700 zones certified in the U.S. and Puerto Rico.

Opportunity Zones have proven successful in providing incentives for investment in areas with historical blight, said Kip Meadows, the founder and CEO of Nottingham in Rocky Mount, North Carolina.

"Many communities are seeing investment and renovation in real estate and, in some cases, relocation of operating businesses to the OZ-designated areas. While the tax and capital gains deferral and cost basis adjustments available under OZ Funds are significant, OZ Funds suffer from complex rules and the need for accounting and timeline maintenance."

The current law is valid only through the end of 2019, he said: the availability of OZ tax treatments will continue, but the maximum benefits available for a 10-year holding period will be reduced by approximately 10% for each year moving forward.

“There is speculation that Congress will extend and renew the OZ Fund legislation, but no bill has been filed as of today,” Meadows told Benzinga.

Due to the complexity, it has taken professionals in the field time to get a handle on the rules and develop rollout strategies, he said. Only a limited number of investors for whom OZ Funds will be beneficial have gone to the trouble to understand and follow through on the strategies.

"While OZ Funds have made a positive impact on many communities thus far, mostly in denser metropolitan areas, the maximum impact countrywide will only occur if Congress extends and renews the OZ legislation and OZ Fund markets have an opportunity to mature and spread."

Pros And Cons 

Opportunity Zones hold a number of potential benefits for investors, said CBIZ MHM's Smith.

“The capital gains that are re-invested are not taxed until the QOZ investment is sold, or on Dec. 31, 2026, whichever is earlier. If you hold the investment for five years, you get a 10% increase in the basis of your QOZ investment, which starts at zero because it consists of deferred realized capital gains," he said.

"If you hold it for seven years, you earn another 5% basis increase, for a total of 15%. Only 2019 investments will be eligible for the full 15% increase, as the deemed sale occurs on Dec. 31, 2026. Finally, if you hold the investment for 10 years, all appreciation on the fund investment is tax-free."

Investors also need to consider a number of potential drawbacks that come with Opportunity Zone Funds.

Investors need to do their due diligence on the ability of fund managers to select appropriate properties and manage them so that the fund is a good investment.

“In other words, if you lose all of the capital gains you deferred by investing in the QOZ Fund, the tax benefits are not going to make up for it,” Smith said.