If you keep up with developments in the investment world, you may have heard about something called an opportunity zone once or twice already.
For most investors though, these zones remain something of a mystery, and investing in them is an unclear process.
Here’s what you need to know about opportunity zones, what advantages they present as investments and how you can start investing in them.
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Table of Contents
What Are Opportunity Zones?
Initially created as part of the Tax Cut and Jobs Act of 2017, opportunity zones are areas designated by the United States government for tax-advantaged investment.
Most opportunity zones are communities that suffer from low incomes, limited investment or other local economic obstacles. Although many such zones are found in inner cities, they run the gamut from deeply urban areas to more rural communities.
The core concept of an opportunity zone is to drive private investment into areas that experience high levels of poverty, thus allowing for improvements to be made in those areas without the need for public tax dollars to be spent.
These private investments, in turn, are expected to create new jobs within the opportunity zone, thus raising incomes and lowering unemployment.
While investors can invest directly in real estate or business equity in opportunity zones, a more popular approach is to invest into a managed opportunity zone fund that holds a portfolio of properties within designated areas.
These funds allow investors to take advantage of the tax benefits attached to opportunity zones without having to arrange deals and manage properties in remote areas.
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Why Invest In Opportunity Zones?
The main reason to invest in opportunity zone funds is that the investment is heavily tax-advantaged compared to ordinary capital gains.
When an existing investment with unrealized capital gains is rolled over into an opportunity zone investment, the gains become eligible for tax deferral until 2026.
Through this mechanism, investors can sell their current assets and put off paying taxes on their profits.
The real power of opportunity zones, however, comes through when an investor holds an asset in a zone for a long period of time.
If an investor holds an asset in an opportunity zone for at least five years, the basis of that investment will be adjusted upward by 10 percent when capital gains taxes on it are calculated. At the 7-year threshold, the investment basis can be adjusted upward by 15 percent.
For assets held in an opportunity zone for 10 years or more, capital gains taxes are waived altogether.
Aside from the obvious tax advantages presented by opportunity zones, there is also a strong argument to be made for real estate in these zones on its own merits as an investment.
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Investing in opportunity zone real estate also gives investors a chance to diversify their portfolios and manage stock market risks.
While the American economy is currently in the midst of the longest expansion it has ever experienced, many investors are looking for alternatives to stocks that will hold their value when the bull market finally comes to an end.
Private investment funds provide just such an alternative, and the other advantages of opportunity zone investment make it a natural fit for investors trying to minimize their tax bills.
Finally, for socially conscious investors, it’s worth noting that investing in opportunity zones is a great way to combine profit and the promotion of the general good. Putting your money into these zones gives you a chance to improve underserved, distressed communities where the effects of investment can have the greatest impact.
Opportunity Zones Funds vs REITs
If you’re an investor with experience in the real estate market, you may have already noticed that opportunity zone real estate funds sound quite a bit like REITs in the sense that both are investment vehicles for managed real estate projects.
While there certainly are similarities, there’s also one important distinction between these two vehicles. Because REITs trade publicly and operate much like stocks, they are also subject to the whims of the investment market.
While this isn’t a huge flaw in the REIT model, it can cause the value of shares in the fund to fluctuate with changing market conditions.
By taking open trading out of the equation, private funds insulate themselves from external factors that aren’t correlated to the value of the real estate in their portfolios.
What Returns Can You
Expect To See?
Due to the fact that each zone is different and that opportunity zone investment is a relatively new phenomenon, it is difficult to say just what kind of returns investors can expect to see when placing their money into opportunity zone funds.
According to some projections, you may be able to realize return percentages as high as the middle teens.
If such projections prove to be true, investment in opportunity zone funds would markedly outperform the long-term average of REITs, which average returns of 11.8 percent annually.
You should also keep in mind that the tax advantages of investing in opportunity zones make for a higher effective return after taxes.
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What Are The Potential Drawbacks?
As with any investment, putting your money into an opportunity zone fund is not a foolproof way to make money.
One of the most obvious downsides that should be taken into account when investing in opportunity zone funds is the sheer time commitment involved.
To get the highest utility from the investment, you’ll need to leave your capital in one place for a period of 10 years. This fact could limit the flexibility of your investments and make it more difficult to reallocate capital into other investment vehicles.
There’s also an argument to be made that opportunity zone investment may rely too heavily on tax incentives and not put enough focus on finding fundamentally good deals.
Just as with any other potential investment, it’s important that you carefully vet any fund or property before putting money into it.
A good rule of thumb to follow is that the investment should make good sense for your strategy and portfolio on its own merits, with the tax advantages being largely an added bonus.
How To Get Started
You could get started in opportunity zone investment by directly buying a business or a piece of real estate in a designated zone.
The easier approach, however, is to use a private real estate fund with opportunity zone investment options.
One of the leading platforms that gives investors access to opportunity zones is EquityMultiple.
Through this platform, investors can put their money directly into an opportunity zone fund created by an experienced real estate investment company.
EquityMultiple also offers real estate investment opportunities outside of these designated zones, making it a good platform for overall portfolio diversification. It should be noted, however, that EquityMultiple is open only to accredited investors.
If you’re looking for a long-term investment with substantial tax advantages and the potential for reasonably high returns, opportunity zone funds may be a good option for you.
Opportunity zone investment is also well worth looking into if you’re a socially conscious investor who wants to achieve both profit and social good through your investment activity.
While they have their potential downsides, opportunity zones offer considerable advantages that could benefit a wide range of investors.
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