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Investing our hard-earned money brings up feelings of uneasiness and stress. Investing involves unknown risks and volatile market behaviors. Entrepreneurs can use real estate to diversify their investments, leverage more money and create passive income opportunities. Qualified Opportunity Zones, or QOZs, can provide a solution for investors looking to diversify their investments.
What is a Qualified Opportunity Zone?
A Qualified Opportunity Zone is a low-income community or neighborhood under economic distress where new investments may be eligible for preferential tax treatment. These investments are designed to provide tax incentives to the investor and incentivize economic opportunities in the community. The U.S. Department of Treasury reviews each nomination before certifying them as a QOZ. There are thousands of QOZs ready for investment.
The 2017 Tax Cuts and Jobs Act created the QOZ program to encourage investors to invest in distressed areas to stimulate the local economy and provide employment opportunities within the community. Potential investors can find these zones within the 50 states, Washington D.C. and U.S. territories.
Individuals and organizations can form a QOZ as long as they fulfill the government-defined eligibility requirements.
What is an Opportunity Fund?
An Opportunity Fund (O Fund) or Qualified Opportunity Fund (QOF) refers to an investment vehicle that invests in a QOZ. These funds are designed for individuals, partnerships and corporations to invest in QOZs. Investors can also use these funds to invest in a pre-existing business or open an entirely new business in the QOZ. The two types of funds are designed to help the investor gain better access to QOZ investments.
Can I open any business in a Qualified Opportunity Zone?
There are usually restrictions surrounding real estate investors’ ability to invest in a property, but with a QOZ, that’s not the case. Investors are only limited to the type of business they open. Investors must choose between two property types: original use property and substantial improvement of the property. The IRS defines a “substantial improvement” as any improvement to a property that increases its worth within 30 days of purchasing it. The IRS defines “original use property” as opening a business that was previously not present before buying the property.
Real estate developments and rehabilitations are among the most common investments made in QOZs. For example, investors may decide to create industrial warehouses or multi-family properties after examining the needs of each unique QOZ.
Tax incentives inside a Qualified Opportunity Zone
Tax breaks and incentives serve as a significant benefit to investing in QOZs and QOFs. Taxpayers can defer federal taxes owed on any capital gains invested in a QOF held for 10 years. This means that anyone who has earned a return from investing in a QOF can postpone paying federal taxes on the income if that investment is held for 10 years.
Aside from federal tax benefits, some states may provide state tax benefits or other additional incentives to invest in QOFs and QOZs. Additionally, investors do not need to live or work in the same state as their QOZ or QOF to reap the tax benefits.
Be sure to speak to your accountant or tax professional to better understand the capital gains incentives when investing in a QOF.
What are the community benefits of a Qualified Opportunity Zone?
Investing in a QOF adds to its overall revitalization while increasing the local economy and job market. Entrepreneurs can invest in large businesses or in multiple small businesses to stimulate local economies and ensure the longevity of the QOF’s impact on the community.
Many real estate investors use QOFs to address local affordable housing shortages. They are heavily involved in development and redevelopment projects, along with projects already under construction.
What should I keep in mind when investing in a QOZ or QOF?
Before investing, aspiring investors should understand the dynamics and needs of the community. This can include the community’s job and income growth rates, crime, vacancy and construction rates. Planning ahead of your investments can be the difference between success and failure. Investors should first focus on improving the community and not on the tax benefits they will receive.
Any tax exemptions made from QOZ funds held for over a decade are irrelevant if the fund’s value has not increased. Investors may face a worst-case scenario in which they would be at risk of losing invested money while also needing to pay taxes on their investment’s increase in value. Like every real estate investment, QOZs have risk involved, but benefiting a community while gaining tax benefits through a QOZ is a great way to diversify your portfolio.
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