Stream Insights, a Thought Leadership Series featuring
Mike Adams, Senior Vice President
Established in the Tax Cuts and Jobs Act of 2017 lies a golden opportunity for investors. Providing tax incentives for investments in designated census tracts, Opportunity Zones have caused a great deal of conversation. The program incentivizes investment by allowing for the deferral of capital gains, reducing tax obligations on a portion of those gains and, most notably, allowing investments to grow tax-free. Although there’s been a lot of buzz, there’s also been some misperception about Opportunity Zone qualifications and requirements.
According to the IRS: “These Zones are designed to spur economic development and job creation in distressed communities . . . by providing tax benefits to investors who invest eligible capital into these communities. Taxpayers may defer tax on eligible capital gains by making an appropriate investment in a Qualified Opportunity Fund (QOF) and meeting other requirements.” A QOF, organized for the purpose of investing in an Opportunity Zone (OZ), can invest funds in a diverse assortment of businesses including commercial and industrial real estate, housing, infrastructure and existing or start-up businesses.
Even with the complexities of the program, one thing is certain according to Stream Realty Partners Senior Vice President Mike Adams, “Opportunity Zones offer investors a chance to preserve capital gains and increase potential capital to reinvest—while making a real, measurable difference in the community.”
In an increasingly competitive real estate environment, these tax incentives create an opportunity for real estate developers to see underserved communities in a more positive light. Real estate investors and developers can invest in areas and communities they may not have considered as locations for viable investment properties, gaining access to incredible tax breaks, preserving capital gains by unlocking substantial tax incentives, while potentially generating additional investment yields and improving communities.
In April 2019 the IRS identified designated Opportunity Zones in 18 states (see a map here), released a secondary set of regulations and answered many questions potential investors had about the program.
Key regulatory modifications released at that time investors should consider:
- Investors can now share stakes in a QOF and are permitted to sell startups in these areas, providing the funds are reinvested in another qualifying business or asset
- Relaxed regulations related to multi-asset fund structures, with only assets in the Fund at for least six months considered as part of the Fund’s qualification as a QOF
- Clarification on the 31-month working capital safe harbor, whereby investors will not be penalized for failure to meet the timeline due to government delays—a piece especially critical for development permitting in California
- Exemption from the substantial improvement requirement for buildings vacant more than five years prior to acquisition
“Triple net leases will not be a part of the program initiative;” states Adams. “Further, there are regulations attached to businesses funded by a Qualified Opportunity Fund; and Qualified Opportunity Funds will have a one-year grace period to sell or reinvest the assets into another Opportunity Zone,” according to Adams.
Initial enthusiasm surrounding the Opportunity Zone announcement appears to have cooled while investors awaited regulatory clarity. Housing Wire reports, “While HUD estimates that Opportunity Zones could spur as much as $100 billion a year in investments, evidence suggests this potential is far from being realized.”
Although there is some potential complexity to investors going “all in” on Opportunity Zone investments, there is still great potential for growth and profit in this initiative that aims to revitalize communities and add strength to underserved areas, with a potential for $6 trillion in capital gains.
In the everchanging and competitive real estate environment, and the push back from local citizens that is oftentimes associated with development, these federal tax incentives can improve struggling communities and create job growth while aligning real estate companies and new businesses that choose to invest in a QOZ. And, while some models have demonstrated potential gains for investors of 200 – 500% base point improvement on their internal rate of return as a result of investing in a QOF, the positive impact on communities cannot be overlooked. Currently, nearly 70% of residents within QOZs live in “severely distressed” census tracts and investment in these communities will ultimately deliver an intriguing combination of financial and social benefits.
Orange County Opportunities
California is optimal for Opportunity Zone investment because of the support and full backing of many state and municipal infrastructures even providing a dedicated website, CA Opportunity Zones, for information about how to invest in QOZs in our state.
Although some investors may not consider Orange County specifically to be a place with many Opportunity Zones, there are actually 28 designated QOZs in the OC. Those 28 Opportunity Zones are found in Anaheim, Buena Park, Costa Mesa, Fullerton, Garden Grove, Huntington Beach, Placentia, Santa Ana, San Clemente, San Juan Capistrano, and Stanton.
The IRS estimates there is more than $4.6 trillion in current capital gains that would qualify for Opportunity Zone investing. But time is of the essence when it comes to investing in QOZs. An investor has six months to invest their gains into a QOF once they have created the gain.
As long-term players in Southern California market, Stream Realty Partners (Stream) have made it our business to be a pioneer when it comes to knowing how to make Opportunity Zone investments work for our clients and we are poised to answer your questions about this chance to make a difference in a community, preserve capital gains and increase potential capital to reinvest.
Stream is at the forefront with funds and investors—and keeping our eye on product in these areas. We have these emergent QOZs in Orange County earmarked, with knowledgeable, prepared brokers ready to help investors take the next step.