Developers, homebuyers and investors may be able to find a bargain in an Opportunity Zone, a distressed, often up-and-coming area eligible for tax incentives. Whether you’re an investor looking for new prospects or a buyer on the hunt for something affordable, here’s what to know about Opportunity Zones, and the areas closest to you that may be worth exploring.
What is an Opportunity Zone?
An Opportunity Zone is “an economically-distressed community where private investments” — in other words, real estate development — “may be eligible for capital gain tax incentives,” according to the U.S. Economic Development Administration. Opportunity Zones are also referred to as Qualified Opportunity Zones, or QOZ.
Created by the 2017 Tax Cuts and Jobs Act, the goal of Opportunity Zones is to boost economic and job growth by encouraging investment in these areas. By making land improvements and purchasing, constructing and renovating properties in these locations, the hope is that the Opportunity Zone will become a more appealing place to live, work and invest.
“What qualifies as an Opportunity Zone are lower-income census tracts designated by the federal government a few years ago. State governments were also able to choose 25 percent of the eligible census tracts in their states,” explains Erik Hayden, a commercial real estate developer and founder of Urban Catalyst, an Opportunity Zone fund based in San Jose, California.
“The overall goal here is to create a positive social and economic impact,” Hayden says.
Opportunity Zones: Pros and cons
Research shows that investments in Opportunity Zones can pay off, including for homebuyers who purchase in many of these areas.
Between the first quarter of 2019 and the first quarter of 2020, 45 percent of Opportunity Zones had their median home price increase by more than the national trend, according to ATTOM Data Solutions. At the same time, the median home price in 78 percent of Opportunity Zones remained lower than the median nationally, $265,900.
Simply put, it can be cheaper to invest in an Opportunity Zone, and many of the areas appreciate more so than the overall trend dictates.
“Because these are distressed areas, Opportunity Zones represent good bargains,” says Tino Jaimes, owner of Sunrise House Buyers TX in Houston. “Fewer buyers are interested in purchasing in these areas, and with less demand the prices are lower.”
A big disadvantage, however, is that homebuyers generally can’t take advantage of the tax incentives associated with Opportunity Zones unless they make considerable upgrades.
“The buyer must ‘substantially improve’ the property during the first 30 months of ownership,” says Rick Sharga, executive vice president of RealtyTrac. “That’s government-speak which means that the owner needs to increase the value of the property by at least the amount he or she paid for the property. So if a buyer purchased a property for $100,000, the property would need to have another $100,000 in improvements to meet the requirements.”
If you simply plan to buy a house in an Opportunity Zone and move in without taking advantage of the capital gains benefits, you aren’t required to make these expensive improvements.
Investors and developers in Opportunity Zones, on the other hand, can leverage the tax incentives.
“These people can be eligible to defer their federal taxes on capital gains,” explains Valla Vakili, Citi managing director and head of Citi Ventures Studio in San Francisco. “They’ll get a 10 percent capital gains tax exclusion after holding onto an Opportunity Zone fund or eligible property for five years, a 15 percent exclusion by year seven and 100 percent exclusion after 10 years.”
Investors can also put existing assets with capital gains into Qualified Opportunity Funds (QOF, the vehicle for investing in an Opportunity Zone), and the taxing of those existing capital gains won’t happen until the asset is sold or the end of 2026.
For investors, though, there are always risks in a distressed neighborhood, which may contain blighted areas with dilapidated structures, unkempt land and otherwise unattractive properties.
“If, for example, you are considering purchasing a rental property and serving as the landlord, you have to ask yourself several questions,” cautions Jaimes. “Is this area safe enough to invest in? Will my property attract tenants who pay on time and won’t damage the property? Will I be here long enough to realize the capital gains tax incentives?”
Additionally, you could have buyer’s remorse if you don’t do your homework. Further investigation may reveal that the community lacks infrastructure, public resources or popular amenities, or that public schools are lacking or the area isn’t attractive as an employment destination, all of which can impact your bottom line.
How to be eligible to invest in an Opportunity Zone
Most anyone can purchase a home or commercial property in an Opportunity Zone, but to take advantage of the tax benefits, the investment has to be through a Qualified Opportunity Fund (QOF).
“[This is] an investment vehicle that files either a partnership or corporate federal income tax return and is organized for the purpose of investing in QOZ property,” says Sharga. “This can be a small company like an LLC, a larger corporate entity or a partnership, usually comprised of investors.”
There are specific requirements involved with filing and being acknowledged as a QOF, so to make sure you qualify, it’s best to hire an experienced attorney.
How to find an Opportunity Zone
Opportunity Zones can be found in all 50 states in the U.S., Washington, D.C., and five territories, including Puerto Rico. In all, more than 8,700 designated Opportunity Zones exist in the U.S. The U.S. Department of Housing and Urban Development (HUD) has a handy online map of Opportunity Zones you can explore.
What if I live in an Opportunity Zone?
If you’ve already purchased a home within an Opportunity Zone, it’s smart to keep tabs on your home’s changing value. Knowing the extent to which your home may have appreciated can be helpful. That’s especially true if you’re considering selling your home, refinancing or tapping into your home’s equity.
“At its core, this program is meant to boost the local economy and enable communities to attract the capital they need to grow,” Vakili says.