In the United States, the location of a person’s home is deeply connected to their economic outlook and their access to various opportunities. Due to a variety of factors, some communities aren’t able to offer many — or any — options when it comes to public transportation, wages, medical care and even groceries. Other communities have ample access to jobs, housing, food, good education and methods of getting around. Discrepancies in access to these necessities can affect people’s health and their ability to thrive while limiting opportunities in a way that negatively impacts quality of life for generations.
Interestingly, individual investors have a chance to help reshape these outcomes for the better. The Tax Cuts and Jobs Act of 2017 included an initiative, called Opportunity Zones, that aims to “spur economic growth and job creation in low-income communities,” according to the IRS. By allowing people to invest in Qualified Opportunity Funds, the program seeks to encourage investment in underserved parts of the United States while offering tax incentives to investors. In this article, you’ll learn more about this program, including how it works, what the eligibility requirements are — and whether it’s working as intended.
What Is the Opportunity Zone Program?
Opportunity Zones are areas that have been designated “economically underserved” based on past census data. Some opportunity zones are low-income neighborhoods in cities. Others are rural areas that are geographically far away from jobs and resources. In an effort to drive business and other beneficial economic opportunities to these areas, Opportunity Zones were created.
Individuals and businesses can both receive tax deferment on their capital gains when they make specific types of investments in Opportunity Zones. As long as an investor continues using their capital gains for further investment in an Opportunity Zone, they can enjoy tax deferrals on their invested funds for up to 10 years.
How Do Opportunity Zones Help Communities?
Opportunity Zones give entities that already have enough wealth to make investments the incentive to do so in communities that need those investments most. In ideal circumstances, these investments come in the form of businesses that serve real needs in a community, give back to the community or make a concerted effort to employ members of the community.
Sometimes, however, investors choose to build businesses that are profitable but not necessarily accessible or meaningful to locals. For example, building an expensive restaurant in the middle of a low-income farming town and building a grocery store that buys food from local farmers are both eligible investments, but only one of them has a lasting positive impact on the local community. Although some critics assert that investors in Opportunity Zones are missing a chance to give back to the communities in more meaningful ways, all investments in the community ultimately have some impact on citizens.
Food deserts — regions where people lack easy access to affordable, healthy foods — are commonly lower-income or rural communities, and the Opportunity Zones program aims to combat food desertification by improving access to healthful foods. A grocery chain is more likely to build a new branch in an area with a low average income level or a lower population if there are tax incentives. This can influence a business owner to build their first store in an Opportunity Zone rather than a second or third store in an affluent area.
If real estate investors choose to invest in Opportunity Zones, their efforts can raise property values, benefitting local homeowners. And if the homes are affordable, they can also provide housing for the local community. Any business that operates in an area creates an opportunity for locals to find employment.
How to Make an Opportunity Zone Investment
The first step in investing in an Opportunity Zone is to find one. While many lower-income areas can use revitalization, an official Opportunity Zone that’s eligible for this type of investment and the associated tax benefits is certified by the U.S. Treasury. The U.S. Department of Housing and Urban Development (HUD) publishes an interactive map identifying certified Opportunity Zones in all U.S. states and territories.
Once an investor has an Opportunity Zone and potential investment in mind, the investor needs to establish an investment fund by completing Form 8996. When the IRS accepts this document, the investor, whether that’s an individual or a business, can establish a Qualified Opportunity Fund. This fund will hold all of the money earned from the investment. After this approval, the investor can make investments inside the Opportunity Zone. The process for making these investments is similar to others, whether the purchase of real estate, buying equity in a business, buying an existing business or starting a new business.
Any capital gains that come from the business are deposited into the Qualified Opportunity Fund. At all times, a minimum of 90% of the money in the Qualified Opportunity Fund must be related to the investment inside the Opportunity Zone. This is a specific pool of money to separate the money that’s meant for use in the Opportunity Zone investment from the other money that the entity owns. Capital gains taxes on the money inside the fund are automatically deferred. If the money stays in the fund for 10 years (and is reinvested in the Opportunity Zone) there’s the possibility of a lengthy deferral in paying taxes on the capital gains that can come along with this type of investment.
How Do Opportunity Zone Investments Work?
To qualify for the tax incentives, investors must meet specific standards. The money they spend on the investment in the Opportunity Zone must come from their Qualified Opportunity Fund. Rather than just banking tax-deferred capital gains for the year, the capital gains go into the fund to provide money for more investments.
For example, suppose Bonnie and Linda form an LLC and submit Form 8996 to the IRS. Bonnie and Linda both contribute $50,000 to the Qualified Opportunity Fund. They spend $80,000 buying a building in an Opportunity Zone and use the remaining $20,000 to make repairs and purchase supplies for their new grocery market. They sell the business later for $150,000. Normally, this would be a $50,000 capital gain. Because this is an Opportunity Zone investment, Bonnie and Linda deposit the $50,000 profit they earn from selling the business back into their Qualified Opportunity Fund and use it for their next investment in the same Opportunity Zone. Bonnie and Linda get to continue investing without paying taxes, and their actions begin to improve local access to food and other goods in the Opportunity Zone.
There are stipulations for investments that can qualify. The purpose of Opportunity Zones is to revitalize local economies, so investors have to take action to improve their investment within 30 days of purchasing it. That could be repairing a home, building a new business or hiring new employees for an existing business. After earning capital gains, investors have 180 days to invest that money.
The full impact of Opportunity Zones on local communities remains to be seen. However, investors and underserved areas stand to benefit from Qualified Opportunity Funds that take the needs of low-income communities into account — and aim to improve conditions over the long term in a lasting way.
