Hornstein Fetter September 2018 Market Insight
by Eric Veith
In recent months, we’ve received a number of inquiries from clients regarding opportunity zones, and how this unique new tax law can be best leveraged by real estate investors in the years ahead. With its dual promise of deferring existing capital gains taxes and wiping out future ones, this tax reform provision is equal parts intriguing and confusing. And the slow trickle of official guidance from the IRS has left many questions unanswered, which has made it difficult for our clients to formulate strategies on eligible investments.
We view Opportunity Zones as potentially beneficial in both direct and indirect ways. The most direct and obvious benefit will come from active real estate investment in one of these zones. Investors that create a so-called “Opportunity Fund,” and use it as a vehicle to invest in real estate within an identified Opportunity Zone, will be eligible for a variety of tax breaks. As we currently understand them, here’s how those benefits break down:
1. Immediate: Deferral of existing capital gain taxes for funds invested in an Opportunity Fund.
a. NOTE: This deferral is not permanent, and this tax liability must eventually be settled
2. Year 5: 10% reduction of existing capital gain tax liabilities for capital invested in the fund
3. Year 7: Additional 5% reduction of capital gain tax liabilities (15% total)
4. Year 10: 100% forgiveness of any new capital gains generated via the Opportunity Fund
Combined, these provisions could mean savings in the millions on many projects. No surprise, then, that many in our world have spent the first part of this year pouring over every scrap of IRS guidance in an attempt to understand the nuances and intricacies of the plan.
But we think it’s worth discussing the less obvious implications of Opportunity Zones as well. Specifically, we’ve been thinking about what, if any, effect this plan will have on the flow of capital into and out of real estate. For instance, will investors be more willing to liquidate investments in other asset classes if it means a reduced tax liability and the opportunity to leverage that money in pursuit of tax-free profits? If so, will enthusiasm about Opportunity Zones be widespread enough to draw significant capital into real estate as a whole, creating a ripple effect across the entire sector? Will there be a spillover effect for properties located near (but not directly inside of) Opportunity Zones? And, perhaps most importantly for us as brokers, will cap rates and values need to start accounting for Opportunity Zones benefits?
These are all very compelling questions for us as brokers, and we’re the first to admit that we don’t have all the answers. But we recognize that Opportunity Zones could have a significant effect on our sector in the years to come, and we’re trying our best to understand the law and its implications. Time will undoubtedly help discern the answers and appropriate strategies, and we will do our best to share updated insights as we continue to learn.
SPECIAL NOTE: We are currently aware of multiple off-market investments that fall within Opportunity Zones here locally, and we would be happy to share more information about them as appropriate. If you are interested in learning more, please don’t hesitate to reach out.
DISCLAIMER: Pinnacle Real Estate Advisors LLC and its affiliates do not provide tax, legal or accounting advice. This article has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Eric Veith | 303.962.9570 | EVeith@PinnacleREA.com