Opportunity Zones in 2021

May 12, 2021
By Soren Godbersen
Posted In: Market Commentary

What is the Present Legislative Climate Around Opportunity Zones?

The Opportunity Zone program has largely fallen out of the spotlight. Perhaps because it has received scrutiny for benefitting developers who may not be acting within the true spirit of the program. Meanwhile, over three years have passed since the introduction of the original schedule for tax deferral and reduction. So where does the program stand today. How might it change going forward under a new administration, and what should self-directed investors regard the program?  

Tax Changes May Stimulate Demand

At the time of writing, the new administration has introduced legislation to dramatically increase taxes. Specifically, the proposed bill seeks to effectively double long-term capital gains tax. We do not know yet what the final, ratified changes to the tax code will be. If there is a substantial increase in long-term capital gains tax, investors may be on the hunt for new ways to defer and potentially reduce their capital gains tax burden. 

Qualified Opportunity Zone (QOZ) Tax Incentives

Opportunity Zone investments provide one possible path. The schedule of tax incentives for QOZ investors has not changed since late 2017, when the legislation initially passed. This means capital gains taxes owed due to a current liquidity event will come due by Tax Day 2027. As such, the original step up in basis for a seven-year hold is no longer on the table. However, several compelling tax incentives are still in play for aspiring QOZ investors: 

  • The roll-over effect: if an investor exits an asset to yield $500,000 in long-term capital gains in 2021, they would normally be on the hook for $100,000 in taxes (20% in the top income bracket). If the investor rolls over the windfall into an Opportunity Zone investment, they can invest the full $500,000 instead of the reduced, post-tax amount, potentially magnifying long-term returns.
  • The Five-Year reduction schedule: while the seven-year step-up in basis has expired, the five-year reduction incentive remains. Investors must incorporate taxes on the initial exit into their tax burden by the end of 2026. Thus, any Opportunity Zone investment made by the end of 2021 allows an investor to defer capital gains tax and reduce their tax burden by 10% if held for five years. 
  • The 10-year elimination: an investor can still potentially pay no capital gains tax on profits from a QOZ investment held for ten+ years. 

Some investors may simply be inclined to take advantage of the deferral mechanism in the hopes of a more lenient tax regime several years from now.

1031 Exchange on the Chopping Block

While the new administration has not specifically discussed future changes to the Opportunity Zone program, it has explicitly called out the elimination of the 1031 exchange program as a means of raising additional tax revenue to offset the cost of stimulus and infrastructure packages. 

It is hard to overstate how common it is for real estate investors to use 1031 exchanges. Congress has estimated volume at $41 billion in deferred taxes between 2020 and 2024, so we can anticipate a sea change in investor mentality and decision-making if the program is eliminated. Some real estate investors may be inclined to remain in an asset — perhaps refinancing — were 1031 exchanges to be eliminated. Others may be newly interested in Opportunity Zones as a way to roll over proceeds from an exit into opportunistic commercial real estate investments. 

It bears repeating that Opportunity Zones investments, unlike 1031 Exchanges, allow for the rollover of profits from non-real estate investments, such as stocks, into real estate. (And through EquityMultiple, with a minimum check size as low as $25k). 

The Program’s Legislative Future

Unsurprisingly, the program’s first few years did not produce overwhelmingly broad investment across census tracts. The most comprehensive study to date concluded that just 16% of the 8,000+ qualified census tracts nationwide have received QOZ investment dollars so far. Critics point out that most of this investment has been in areas that were already in the process of gentrifying. Boosters and critics alike are seeking more guidance on the impact of QOZ investments. Specifically, as pertains to the stated goal of improving affordable housing stock and job growth in historically under-invested areas. 

A collection of business groups who support the program are pushing for other enhancements to make QOZs both more enticing to investors and more true to the program’s stated intent, including:

  • A rolling forward of the tax deferral and reduction schedule.
  • The allowance of aggregator and “feeder” funds, allowing smaller investments into larger QOFs.
  • Relaxed standards for “original use” to allow for more flexible use of the program when it comes to affordable housing projects that entail rehabbing existing assets. In other words, allowing QOZ dollars to flow into a broader set of affordable and workforce housing investments. 

In general, though, the new administration appears most focused on infrastructure legislation, and is unlikely to propose significant changes in 2021. This still leaves plenty of compelling options for investors.

What do Self-Directed Investors Think About Opportunity Zone Investments Today? 

Perhaps related to the factors stated above, self-directed accredited investors are showing a renewed interest in Opportunity Zone investments. Uncertainty regarding the program has, no doubt, tempered interest. Many investors are also marginally more focused on payment priority and near-term cash flow at this point in the recovery. 

In recent surveying of our investor network, we observed fairly wide dispersion among self-directed accredited investors with respect to interest in Qualified Opportunity Zone investments.  

Though a large percentage of investors have little interest in the program, we have heard in numerous discussions with investors that Opportunity Zones are now more appealing than ever, particularly if the deferral schedule is reconstituted or if census tracts are re-designated. For further sentiment on Opportunity Zones, please see this whitepaper. 

Opportunity Zones & Post-Pandemic CRE Trends - Investor Sentiment Survey

Equity Multiple Document
Real Estate Investing In A Post-COVID World.

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