Established by the Tax Cuts and Jobs Act of 2017, Opportunity Zones are an economic development tool designed to promote investment in distressed communities.
These areas often suffer from high poverty and unemployment rates, low median incomes, and limited access to quality education and jobs.
By providing federal tax benefits to investors, the government aims to reduce these communities’ economic decline, population loss, and physical decline. The Opportunity Zone program is voluntary, with no minimum investment required.
As of November 2022, there are more than 8,700 designated Opportunity Zones across the country, including Puerto Rico and Washington, D.C. Large metro areas like New York City, Los Angeles, and Chicago top the list of cities with the most Opportunity Zones.
What Are Opportunity Zones & How Do They Work?
Also referred to as a Qualified Opportunity Zone (QOZ), these zones are intended to encourage long-term investments in low-income urban and rural communities left behind as the economy evolved.
To be designated as a QOZ, an area must first receive a nomination by its state, then obtain certification from the U.S. Treasury. Each state can set up to 25% of its eligible census tracts as Opportunity Zones.
Investors contributing to a QOZ can benefit from tax advantages, such as deferral of capital gains taxes on any prior investment until 2026. And after holding the QOZ investment for at least ten years, any capital gains on the investment sale are exempt from taxes.
In addition, you can use investments made through a Qualified Opportunity Fund (QOF) to finance businesses or real estate projects located within one or more Opportunity Zones.
QOFs are private investment vehicles organized as partnerships or corporations to invest in an eligible Opportunity Zone business property.
Why Are Opportunity Zones Important?
Created to incentivize investment in low-income communities, Opportunity Zones aim to boost long-term economic growth and job creation in these areas.
According to the Economic Innovation Group, a think tank that played a significant role in designing the program, Opportunity Zones could attract around $100 billion in investment funds over the coming years.
Opportunity Zones hold the potential to:
- Spur economic development in underserved communities
- Assist with job and small business creation, which can help reduce poverty and crime rates
- Attract new businesses to an area that can provide additional services and products to the community
- Improve the quality of life for residents of an area by providing new amenities and opportunities
- Provide benefits for investors through a tax break
Investors who put their money into Opportunity Zone businesses and real estate projects can make a tangible difference in struggling communities.
These areas usually don’t have access to traditional forms of financing. As a result, the Opportunity Zone program could be the turning point for underserved neighborhoods.
What Are the Benefits of Investing in an Opportunity Zone?
Regarding real estate investing, Opportunity Zones offer a unique set of benefits. Here are a few significant advantages of investing in an Opportunity Zone:
One of the most significant benefits of investing in an Opportunity Zone is the variety of taxpayer incentives available. These tax exemptions can help offset the costs of your investment, making it more affordable and profitable in the long run.
Return on Investment (ROI)
Because these areas are typically underserved or underdeveloped, there is often more room for growth and appreciation than in other markets. This can lead to higher profits when you eventually sell your property.
By spreading your investment across multiple properties in different areas, you can mitigate some risks associated with any single investment. This diversification can lead to increased stability and profitability over time.
In addition to taking advantage of the financial benefits of investing in an Opportunity Zone, investors can positively impact the community. By redeveloping a blighted area, you can help revitalize a community and make it a better place for generations.
What Are the Risks of Investing in an Opportunity Zone?
While QOZ investments offer plenty of potential benefits, there are also risks to keep in mind.
The risks associated with investing in an Opportunity Zone include:
- Expected economic growth may not take place in the distressed area.
- The investment may not perform as well as expected.
- If the program abruptly ends, the investor’s tax benefits may fail to materialize.
- Other investments in similar areas may outperform the Opportunity Zone investment.
- Changes in government policy could adversely affect the investment’s value.
To determine if the risk is worth the possible reward, note these considerations before investing in an Opportunity Zone.
How To Find & Invest in an Opportunity Zone
Start looking for an Opportunity Zone online using the Department of Housing and Urban Development’s (HUD) map tool. This will allow you to see if any areas you’re interested in are Qualified Opportunity Zones.
Some states have created dedicated websites for these zones, with many providing updates on successful projects. For example, use the California Opportunity Zones to check out designated areas across the state.
In addition, the Internal Revenue Service (IRS) has plenty of resources about Opportunity Zones, including facts and details on income tax breaks and deferred gains. After pinpointing a few potential Opportunity Zones, conduct thorough research to determine which zone is correct for you.
Consider factors such as the location of Qualified Opportunity Zone property, the available property, and the tax benefits offered.
When you’ve found an opportunity zone that meets your needs, the next step is to invest in it. There are a few different ways to do this, including purchasing a property outright within the zone.
Another approach is to invest in a business situated within the zone. You could also fund a real estate investment trust (REIT), which allows you to invest in property without purchasing it yourself.
Whichever method you ultimately choose, do your due diligence. In addition, be prepared with a contingency plan in case zoning changes or other regulations affect your investment.
How To Finance Properties in Opportunity Zones?
While you are not barred from financing properties in opportunity zones using any type of loan, the only way to capitalize on the unique tax benefits is by making your investment through a QOF. Many QOFs have a minimum investment amount, ranging from as low as $100 (Oprine Opportunity Funds in Seattle) to as high as $25M (Bedford Funds in Pittsburgh).
Additionally, most QOFs are regionally specific. Depending on the location of the Opportunity Zone you’d like to finance property in, you will have different options.
Is the Opportunity Zone Designation Effective?
Many projects have used the Opportunity Zone designation to attract investment, including mixed-use developments, affordable multifamily housing, and commercial real estate projects.
Here are several success stories about Opportunity Zone revitalization projects:
- The construction of a new light rail line in Seattle, Washington, will connect downtown to the city’s airport.
- The redevelopment of a formerly vacant 75,000-square-foot cold-storage facility in Detroit, Michigan, into Chroma is an art project, coworking office space, and event venue.
- The Brooklyn Navy Yard in New York City turned into a modern industrial park with more than 300 businesses.
- The South Market District in New Orleans, Louisiana, became a mixed-use real estate development featuring residential, office, hotel, and retail space.
By encouraging investment in low-income areas, the program may promote community development, reduce poverty, and improve economic outcomes for residents in designated zones.
Bottom Line: Are Opportunity Zones a Good Investment?
The federal government created Opportunity Zones to bolster new investments in economically distressed communities. The program offers tax benefits to investors who invest capital gains in designated areas.
The idea behind Opportunity Zones is that investments can help revive and modernize these communities and create jobs. The tax breaks are meant to advocate for long-term investment instead of quick flips.
Certain groups do have concerns about the program, however. Some worry that the tax advantages will mainly benefit wealthy real estate investors rather than the residents of these communities. There is also concern the program could lead to gentrification and displacement of residents.
With these concerns in mind, Opportunity Zones could still be a good investment for those looking to make a difference in struggling communities.
The tax benefits may encourage more investment than would otherwise occur, and if done right, the program could help stimulate economic growth in these areas.