Opportunity Zone Fund Investing – Pros and Cons
There are few things worse than earning a great deal of money in some sort of financial victory—a successful business, a jump in the stock market, or a profitable real estate deal—only to realize that a large chunk of your hard-earned money is going to be taken for capital gains taxes.
Talk about a bummer.
Financially-savvy investors will be on the lookout for ways to save money in taxes after large gains, and the Tax Cuts and Jobs Act of 2017 has given these investors a way to both save money and do good in their communities.
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The Tax Cuts and Jobs Act was created in order to better stimulate the economy. The idea is that the rich can receive a tax break in exchange for investing their money into something that will encourage economic growth in the US. These investments might be real estate, which seems to be a relatively common Opportunity Fund, or re-development, business development, and miscellaneous other portfolio options that will feed back into the economy and help more people reach financial security.
What is an Opportunity Zone Fund?
There is a demonstrated need for economic growth, particularly in our lower-income communities in the United States. In fact, it has been reported that between 2010 and 2015 jobs have been dropping in economically impoverished areas, new businesses have been opening at increasingly slower rates, and growth is unevenly maintained across the country.
All of these findings are alarming, as they paint a bleak picture of America: we are simply not in a consistently good place financially.
In an attempt to reach their goal of stimulating the economy and providing benefits to low-income, low-opportunity citizens, the government created Opportunity Zone Funds, which offer investors three key benefits:
- Investors can defer their capital gains and thus not pay taxes on the gains until the year 2026.
- Investors may reduce the amount of taxes they pay on the capital gains overall. Opportunity Funds can relieve up to 15% of the original tax amount.
- If investments are untouched over 10 years, the interest earned may be entirely tax-free. The rate of savings varies by the number of years the investments are held.
Investments must be made within 180 days of the sale that resulted in the capital gains, so investors need to take care not to let this deadline pass; after the 180 days, an opportunity fund will no longer prevent investors from hefty taxes.
In order for an Opportunity Zone to be approved, it needs to be considered low-income. These zones were chosen by state governors, which is interesting; it demonstrates that people who are intimately familiar with the zones in question have chosen them because they represent the greatest need—and greatest potential growth. It is also clear that these zones should offer a mix of urban and rural communities in order to ensure that diversity of growth is maintained.
Who Should Invest in an Opportunity Zone Fund, and Why?
Investors with large capital gains who do not need the money immediately would benefit from investing in an Opportunity Fund more often than not. Unless the capital earnings are needed for another purpose within the next few years, investors will find a drastic reduction in the amount of taxes they need to pay on these earnings.
Additionally, investors will have more money to invest upfront if they utilize an Opportunity Fund.
Imagine this: A man earns $1.5 mil on an investment and will need to pay $300k in taxes on this growth. If he pays taxes on the capital gains, he will only be able to invest $1.2 milion; however, if he immediately invests in an Opportunity Fund, he will be able to invest the entire $1.5 million.
This gives the investor even more money to work with, which does two things: first, ensures that the investor is compounding her returns on a larger sum; and second, it further stimulates the economy with an additional $300,000.
How Can I Invest in an Opportunity Zone Fund?
There are quite a few places that allow you to invest in Opportunity Zone Funds! As with any investment, it is essential that you choose both a company, an advisor, a portfolio, and a mission that you can live with.
In particular, Opportunity Funds can make a near-immediate difference in someone’s life. Investing in these funds is a smart way to make sure your money really makes a difference.
- Fundrise offers Opportunity Funds that focus on real estate. The company invests in “major US cities with long-term growth potential” to help investors make the best use of their capital gains. Fundrise also boasts an approach to investing that is low-cost.
- Caliber’s Opportunity Funds utilize diversified portfolios to help clients reinvest their capital gains. Their website offers a link to a map that illustrates opportunity zones so that investors can better understand where their funds can go geographically.
- Cresset Capital has recently partnered with a real estate investing firm to provide Opportunity Funds across all the United States. The investment options include real estate, development, re-development, and private company investments.
In most cases, you must be a qualified or accredited investor to purchase shares in an opportunity fund. The Motley Fool has a nice article on qualified investors.
A qualified investor is permitted by the Securities and Exchange Commission to invest in riskier “private placements,” such as hedge funds, venture capital funds, private equity offerings and other private placements.
To be considered a qualified investor you must meet one of the following criteria:
- Earned $200,000, if single, or $300,000 when combined with spouse’s earnings during each of the last two years. (And expect to earn the same amount in the current year.)
- Have a minimum net worth, either alone or with a spouse, of $1,000,000 excluding your primary residence.
Opportunity Zone Fund Disadvantages
While opportunity zone funds appear great, on paper, there’s little oversight. While the US treasury and IRS are charged with monitoring the program, their oversight mechanisms aren’t fully set up yet. That means that anyone could create a fund and solicit investors. There’s no guarantee that the projects will fit with the opportunity zone guidelines or that the project will be successful.
There are also very specific details about how to defer capital gains by investing in an opportunity fund. So, you must perform you due diligence to make certain that you understand how the program works and whether your investment meets the opportunity zone tax benefit. The IRS website states that there are more details about the program forthcoming.
The Takeaway: Opportunity Zone Funds Can Work!
The American economy has had its fair share of ups and downs over the last few decades. Opportunity Zone Funds are just one way for wealthier investors to pay back their communities in a tangible way, and the benefit of receiving referred and lowered taxes is an added bonus.
As long as the money from these capital gains is not needed right away, an Opportunity Fund can help investors use their money to grow their wealth. By deferring the taxes on capital gains, investors are given even more money to invest up-front, which makes a greater difference in the Opportunity Zone.
As with any new investment opportunities, proceed with caution and make certain to understand potential risks as well as the rewards.