How to navigate the benefits and risks of opportunity zones

Opportunity zones have captured the attention of many. This program, developed under the federal tax reform, is a tax incentive to develop distressed areas. Investments are made through a qualified opportunity fund for the purpose of investing in these assets.

“There’s quite a bit of interest, seeing what’s on the market, what it’s going to cost and the projected benefits,” says Jim Komos, tax partner-in-charge at Ciuni & Panichi, Inc. “I think it’s going to reawaken projects that didn’t make economic sense before.”

Smart Business spoke with Komos about this innovative program, which is designed to promote development in economically distressed areas by delivering tax benefits to investors.

How are opportunity zones different from programs that have been tried before?

To create opportunity zones, states took census tracts with low property values and decided where they want to encourage development. It’s broader in scope than prior programs. Empowerment zones or renewal communities might have picked 40 or 50 qualifying areas. More than 8,000 opportunity zones have been identified throughout the U.S. and its territories.

The program also isn’t subject to as much bureaucracy as other programs, such as the earned income tax or new market tax credit. Opportunity zones are much simpler.

Who benefits from opportunity zones?

Property owners and residents are one beneficiary. Property is worth more and residents may see their neighborhoods spruced up with new facilities or construction redevelopment. In some cases, business owners who have been wanting to move may now be in an opportunity zone. This program could open up the market.

Developers and investors benefit in three ways:

1. They can defer taxation on capital gains for up to 10 years if they invest in an opportunity zone. However, those gains must incur within six months of the investment. Many investors are looking at opportunities within the zones prior to incurring a gain — selling a property — and creating the related opportunity fund.

2. If they stay in that fund for at least five years, 10 percent of that gain is eliminated. If they stay for seven years, another 5 percent is wiped off the books.

3. If they have gains on their opportunity zone investment, it will not be taxed. For example, an investor buys a factory for $1 million, and then sells it for $2 million 10 years later. That $1 million appreciation will not be taxed.

What restrictions could limit who can benefit from opportunity zones?

Along with making sure the opportunity fund application is filed by the developer, there are some investment restrictions. In most cases, 90 percent of the property, or the assets in that fund, have to be qualifying assets. There are different definitions of qualifying assets, whether it’s an operating business or real estate. (Real estate is a little more restrictive.) Generally, investors need to be improving the property or bringing new business into the area.

Where are the opportunity zones in Northeast Ohio?

Broadly, most of the downtown areas of major cities fall into the opportunity zones. That means much of downtown Cleveland, quite bit of downtown Akron, Youngstown, Warren, etc. But, surprisingly, there are other areas like around Warrensville Heights that also fall into an opportunity zone. For a full listing, including a map broken down by address, visit this opportunity zone resource page from the U.S. Department of the Treasury.

What are some risks to be aware of?

This is a hot topic, but investors need to be careful. They should work with people who know what they’re doing to ensure their investments will actually qualify for the exclusions and deferrals.

In addition, investors shouldn’t overpay or get taken in by high fees. Too often, people are so excited about the tax benefits and deferring the tax, they don’t realize they’re paying too much for the property. Or, if they’re investing through a developer, the developer takes too much for himself — rather than getting 20 percent of the upside, maybe he’s taking 30 percent. So, investors must make sure, overall, it’s a good economic investment.

Insights Accounting is brought to you by Ciuni & Panichi, Inc.