The recent surge in alternative investments is just the beginning of a new growth wave fueled by rising volatility and central bank changes. Asset managers are shifting their asset under management mix and rebalancing portfolios with an eye towards alternatives. But with portfolio rebalancing comes tax liabilities. Portfolios and/or investors sitting on large capital gains from real estate, stocks, bonds, and nearly any other asset may defer taxes by transferring those gains into qualified Opportunity Zone Funds.
Established under the Tax Cuts and Jobs Act of 2017, Opportunity Zone legislation creates a framework for encouraging investments in distressed communities throughout the country. The Opportunity Zone program creates a set of tax incentives for investors with unrealized capital gains to invest capital into low-income communities. Investments must be in either a Qualified Opportunity Zone real property or businesses. Opportunity Zones, which are located in every state, are intended to be advantageous for both distressed communities needing investment dollars and investors looking to minimize capital gain taxes.
The Federal program reportedly taps an estimated $6 trillion in unrealized capital gains to fuel growth and development in low-income communities. Gains may be reinvested from any existing investments within 180 days into an Opportunity Fund and defer or reduce those capital gains taxes (Internal Revenue Code Sec. 1400Z). To incentivize investments, the legislation uses a combination of tax treatments to benefit taxpayers including:
Temporary deferral of capital gains invested in opportunity funds through 2026;
Step-up in basis increases 10% if held 5-years plus and an additional 5% if held for 7-years plus;
Permanent exclusion of new capital gains if the investment is held for over 10-years.
Although investments are fact-dependent, unlike a 1031 exchange where proceeds need to be reinvested in a like-kind exchange, Opportunity Zone investments include all eligible assets, (e.g., real estate and non-real-estate assets) and only capital gains need to be invested. The program provides incentives to focus on community revitalization over the long-term while providing downside protection and low correlation to cycles. In addition to tax incentives, there are several reasons to include real estate in a multi-asset portfolio, including potential return enhancement, risk diversification, inflation hedge/protection, and low volatility.
As of June 14, 2018, the U.S. Department of Treasury and Internal Revenue Service announced the final round of Opportunity Zone designations. Approximately 35 million Americans, across all 50 states and five U.S. possessions, live in the communities designated as Opportunity Zones. The average poverty rate in these areas is 32 percent whereas the average U.S. census tract is 17 percent. In general, the median family income is less than 80 percent of the surrounding areas. Qualified Opportunity Zones retain this designation for 10-years creating certainty when it comes to investments. The Opportunity Zones that have already been approved can be seen on a map available at: http://eig.org/opportunityzones.
Embedding genuine sustainable impact practices will further support systemic change in distressed communities and develop value aligned investments that are also compelling and profitable to investors. Identifying pockets of value in Opportunity Zones and property sectors, which can have distinct liquidity, supply and demand drivers, will require a granular investment strategy.
The momentum behind Opportunity Zone Funds may be tax-related, but at Highmore we believe there is tremendous opportunity to do good while simultaneously having a lasting multiplier impact on communities. We are deeply committed to advancing and expanding premium value-aligned investment opportunities. Doing well and doing good are not mutually exclusive. Opportunity Zone Funds will enable investors to not only take advantage of favorable tax benefits, but will help establish new norms for economic activity that are better aligned with economic, environmental and socially sustainable goals that benefit future generations.
 Qualified Opportunity Fund is an investment vehicle that is set up as either a corporation or partnership, that utilizes investor’s gains from a prior investment for funding the Opportunity Fund, that holds at least 90% of its assets in Qualified Opportunity Zone Properties.
Disclaimer: The information contained herein, and in any attachments, has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy, completeness or timeliness of this document. The material herein does not constitute the provision of investment advice and is not intended to do so, but is only intended as general information. This material is informational purposes only. This is not an offer, advice, recommendation or solicitation to buy or sell any security, commodity or instrument or related derivative, nor is it an official confirmation of terms. Highmore is providing this communication on the condition that it will not form the primary basis for any investment decision you make. Highmore does not render legal, or tax advice and the information contained in this communication should not be regarded as such. Investors should consultant with their accounts and attorneys regarding their individual tax status.
Compliance code: 814201803
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Joseph Julian, PhD