A veteran tax consultant explains how the newly created Qualified Opportunity Zones offer incentives to provide workforce housing in economically distressed areas.
- The Tax Cuts and Jobs Act offers federal tax benefits for investments in certain low-income communities designated as Qualified Opportunity Zones.
- Tax incentives will promote job and wage growth in these zones, increasing residential housing demand.
- By building workforce housing in Qualified Opportunity Zones, developers can benefit from new tax advantages and meet increased housing demand.
The Tax Cuts and Jobs Act of 2017 offers a significant tax incentive for long-term investments in Qualified Opportunity Zones. The zones are low-income communities located in all 50 states, Washington, D.C., and five major U.S. territories.
Prior capital gains proceeds reinvested through Qualified Opportunity Funds in Qualified Opportunity Zones are eligible for tax deferral and potentially also for permanent tax exclusion, depending on the length of the investment. In addition, a permanent exclusion of future appreciation is possible if the opportunity fund is owned for more than 10 years.
A qualified fund’s investments can be in qualified stock, partnership interests, or business property within the zone. For developers, this offers an attractive advantage. Using Qualified Opportunity Zones for workforce housing will allow real estate developers to obtain preferential tax treatment, as well as spur development and provide housing in economically distressed areas.
How to Qualify
Developers and other taxpayers can elect to invest up to the full amount of their prior capital gain within a 180-day period from the date of the original sale in a Qualified Opportunity Fund. That vehicle is a corporation or partnership that holds at least 90 percent of its assets in “Qualified Opportunity Zone Property,” as measured on the final day of the first six-month period of the fund’s taxable year, and again on the final day of the taxable year.
Through qualified opportunity zone funds, developers can utilize real estate in a Fund such that the real estate qualifies as “Qualified Opportunity Zone Property” for purposes of meeting the 90 percent threshold. To qualify, three conditions must be met:
- A developer must purchase the property after Dec. 31, 2017.
- A developer must use or substantially improve the property. The property is considered substantially improved if, during any 30-month period after the acquisition, there are increases in the basis of the property that exceed the property’s adjusted basis at the date of acquisition.
- The property must be used in the Qualified Opportunity Zone during all of its holding period by the fund. (Clarification by the IRS of the requirements for qualified funds will be a welcome step.)
While ordinary operating income in the property will still be taxed, tax benefits are achieved from holding an investment in a qualified fund. Qualified Opportunity Funds offer three different tax benefits to real estate developers depending on the how long the investment is held.
1. Developers can temporarily defer taxes on capital gains until the earlier of the date on which the replacement property is sold, or until December 31, 2026.
2. For investments held more than 5 years, the basis on the original capital gain is increased by 10 percent of the original gain, while for investments held at least 7 years or more, the basis of the original capital gain is increased by 15 percent.
3. To take full advantage of the new law, developers holding the investment in the fund for at least 10 years can elect to increase their basis in the fund to the fair market value on the date of the sale of the fund, and pay no capital gains tax on the appreciation of the fund.
A list and interactive map of Qualified Opportunity Zones can be found on the Community Development Financial Institutions Fund website. These zones often are the most distressed neighborhoods or areas undergoing heavy gentrification, where rising home prices force local residents to relocate.
Defining the Zones
Workforce housing is usually defined as residential units for households with incomes between 60% and 120% of the local average median income. By providing workforce housing in Qualified Opportunity Zones, developers can benefit not only from the aforementioned tax incentives, but also from increasing demand for affordable housing in low-income communities.
Qualified Opportunity Zones must have a poverty rate of at least 20 percent or a median income that does not exceed 80 percent of the median family income of the geographic area where the zone is located. Zones were chosen for proven growth potential, as measured by number of existing jobs and businesses, and employment growth from 2011 to 2015.
It is hoped that the new law will inject capital into Qualified Opportunity Zones, allowing these areas to develop substantially in the years to come. The investments will create new jobs and increase wages, thus generating higher demand for workforce housing.
Workforce housing development can provide a tangible solution to housing problems many low-income individuals face. It is also offers attractive returns to developers investing in communities that are most in need.
Don Linzer is a veteran tax consultant and chairman of Schneider Downs Corporate Finance LP. Sophie Xu recently interned at the firm as an investment banking analyst and is a student at Yale University.
Schneider Downs Corporate Finance, LP is a registered broker/dealer, member SIPC.
Note: Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as investment, tax or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.