The Wizard of OZs: What you should know about opportunity zones.

Financial Planning Dentist

What is a Qualified Opportunity Zone Property?

The 2017 Tax Cuts and Jobs Act created special tax incentives for those willing to risk their own capital to improve and develop the real estate in traditionally underinvested sections of the country called opportunity zones. The goal was to raise long term capital by incentivizing investors that historically wouldn’t invest in these types of opportunities due to the inherent risk. They’re designed with the purpose to benefit the denizens of those locations and investors looking for sizable tax incentives to commit capital. The Qualified Opportunity Zone program is the solution that provides that tax incentive for private, long-term investment in economically distressed communities.

What makes it a Qualified Opportunity Zone (QOZ)?

The definition for this type of zone is “economically-distressed communities where new investments, under certain conditions, may be eligible for preferential tax treatment.” The process for designation of the OZ is pretty straight forward. All 50 states are allowed to submit a list of blocks of low-income tracts across their state based on census data. The Treasury then approves their inclusion in the program or not (most were approved). Plans are now in place with municipal and state governments to commit to projects that bring new construction projects into these areas.

What are some unique risks you should be familiar with before you invest in an OZ?

  1. Market Liquidity – the markets for these investments are immature. There is a sizable pool of available capital for investment, but most of it is from long view institutional investors. The long term, committed and disciplined capital on the ask side, and the insurability for most investors in this space supplying the bid likely means that the spreads widen and limit overall liquidity for investors.
  2. Vehicle Liquidity – The types of vehicles offering exposure to this space are limited, largely non traded REITs. These agreements have a very long view of the investments and capital and few offer the liquidation windows and frequency temperamental investors might be used to. Asking yourself what kind of liquidity and income requirements do you have in your investment plan is more important than ever. Investors seeking income starting day 1 may need to find investments that reflect that and will see their upside limited as a result. Those seeking to “time the market” through this development will be frustrated by the duration of these investments. 
  3. Investment Risk – investment in “economically-distressed communities” carries a very unique risk that the investment will not perform on par with other parts of a city or market. Their unique performance risk with these investments will never go away, simply put you are buying into a major turnaround story in some parts of the country that may never come. This is mitigated by a few factors, the managers selecting and overseeing the projects are more important than ever. Picking the right project, with the right builder, in the right neighborhood is more important than ever. 
  4. Intent – why are you committing capital to these projects? Is it only for income? Are there parts of the country that have an emotional connection to their success? Is this a good attribute or a negative? I think it’s important to have a real honest sense of purpose in these investments. Not only to help understand and mitigate the risks involved but to help you price in the purpose of this investment. More and more people want to know that the dollars they are investing are being used for societal benefit, but make sure you are handicapping that expectation appropriately.
  5. Tax – The tax benefit for OZ’s has a pretty long ark, and the year over year benefit changes over time. Before you enjoy the tax benefits afforded here you should confirm a couple of assumptions. First, that your tax liability is ample enough to enjoy the full benefit, second, that your tax strategy for the next decade marries well with the long term requirement of this investment and third, there are no alternative strategies for a similar tax benefit with less inherent risk. Confirming these three elements of taxation and its accompanying strategy is an essential step for your CFP and CPA before you should consider the upside of this program. 
  6. Statutory Risk – the Tax Cuts and Jobs Act (TCJA) is current law, and planning for current law is not the issue. Tracking and making sure this new tax strategy stays intact going forward should be on an investor’s mind and having a plan of action if and when conditions change is part of the monitoring process for both your entire plan and this specific investment. Laws change and this opportunity is set to expire 12/31/2026. 
  7. Regulatory Risk – as I said before, the inclusion of a region in an opportunity zone is pretty straight forward, but the regulatory requirement for maintaining that acceptance by the U.S. Treasury is still important. Making sure that the project, builder, and fund all stays focused on the regulations that keep it inside the tax purview is eminently important. Selecting a manager that is versed in the regulations and will do the property due diligence to stay in the lane is important. The risk is the loss of the tax benefits you have likely priced into your expectations. 

Opportunity Zones have the ability to be truly transformative for communities and investors. A fantastic marriage of social benefit, long term capital investment, and tax benefit make for an appealing place to see a reasonable return. But taking advantage of this program for non-institutional investors is going to have a few parties you should consult to confirm the investment is right for you:

  • a CFP to confirm that this investment works in your personal financial plan
  • a CPA that understands the full tax benefits of this investment
  • an estate plan that can accommodate the long duration of this type of an investment
  • an investment manager that understands and mitigates the risks as best as possible
  • an investment advisor that helps you understand vet the vehicles and nuance in the opportunity set

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