Under the Tax Cuts and Jobs Act of 2017, a program was created that offers investors favorable tax treatment for investing capital gains in Qualified Opportunity Zones, areas in each state designated by their governors as distressed communities. The idea is to encourage investment to spur economic growth and development by pulling idle capital gains off the sidelines and into areas of need.
Smart Business spoke with Michael D. Makofsky, a principal at McCarthy, Lebit, Crystal & Liffman Co., LPA, about Qualified Opportunity Zones and what investors should know about them before investing.
How do Qualified Opportunity Zones work?
Investing capital gains in a Qualified Opportunity Zone is done through a Qualified Opportunity Fund (QOF), which is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property within these zones. Many investment firms have formed these funds, and they operate under certain requirements. For instance, generally 90 percent of the fund’s investments must go to a property or a business that’s located in a Qualified Opportunity Zone. Further, real property that gets the investment has to be substantially improved over time (and there’s criteria for what exactly ‘improved’ means) and a percentage of a business’s income must derive from business activities within the Qualified opportunity Zone.
When an event occurs that creates capital gains, the benefactor needs to make an investment in a QOF within 180 days. In exchange for the investment, there’s a tax deferral on the capital gains invested until the earlier of (1) the investment being sold or (2) December 31, 2026. There’s also an incentive to keep the investment in the QOF. Money that stays in that qualified property or business for five years will get 10 percent of the applicable capital gains tax permanently eliminated. If the investment stays for seven years, a total of 15 percent is eliminated. After 10 holding years, any gains in excess of the original investment value become tax-exempt.
How is Ohio to trying take advantage of Qualified Opportunity Zones?
Ohio introduced legislation to provide an additional state income tax credit of up to 10 percent of the investment. The state senate has passed the bill, and Gov. Mike DeWine is in favor of it, so it’s expected to pass.
Cuyahoga County is working to promote this program as well. The county set up Opportunity CLE, which has its own website for prospective investors and developers that highlight area Opportunity Zones. The county sees this as a big opportunity for the area.
What does the early feedback suggest about investment activity in Ohio’s Opportunity Zones?
There’s still a lot to be determined when it comes to measuring the effectiveness of the Opportunity Zone program. Investors seem interested because they see the potential benefit, but even from the initial data, it’s too early to tell if it will have the benefit proponents anticipate.
In some cases, the investments that are being made in Opportunity Zones are for projects that would be undertaken anyway. The tax credit becomes another incentive rather than the reason for the investment — it doesn’t seem to be an investment driver at this point.
There are regulations tied to the program, which could have a narrowing effect on the field of potential investors. But more information and time are needed to determine whether the program can produce the desired effects.
What misunderstandings are common among those interested in investing in Opportunity Zones?
Investors seem to overlook the timing restrictions that dictate when they can invest. Also, there is some misunderstanding regarding what qualifies as an investment and what has to happen to the investment property for it to be considered improved.
Investors need a thorough understanding of all of the QOF and Opportunity Zone guidelines and regulations before deciding if these opportunities make sense. Talk to professionals who are keeping up on these opportunities — accountants, lawyers — to get a better handle on the potential return.
Insights Legal Affairs is brought to you by McCarthy, Lebit, Crystal & Liffman Co. LPA
