Tread Carefully With Opportunity ZonesThe 2017 tax bill created an exciting opportunity for real estate investors – opportunity zones. To incentivize real estate development in these areas, the IRS is offering to defer and eliminate some capital gains taxes on these transactions. For instance, the gain on the real estate will not be taxed if you hold it for 10 years. That sounds good, right? Let me remind you that exciting opportunities are not the same as good investment opportunities. Here are some things to be mindful of:
- There is a lot of money pouring into opportunity zones because people get excited about avoiding taxes. That is pushing up the cost of investing and lowering future returns.
- Holding a real estate development investment for 5+ years implies that you don’t need the money before that. This had better be money you don’t need to live on.
- One of the big draws of opportunity zones is that they defer taxes on the asset you sell to fund them. Let’s say you sell some highly appreciated stock. I have some clients with 1000% appreciated stock from their former employer. Being able to diversify that and defer taxes sounds like a great idea. However, that tax is still due eventually. The latest it can be paid is 2026. Deferral is better than nothing, but the tax is still due soon enough.
- Never make an investment based only on the tax characteristics. You have to do a lot of due diligence on a direct real estate investment (even if it’s through a fund). Remember, opportunity zones are described by the IRS as “an economically-distressed community” (emphasis mine). It would be fantastic to hold an opportunity zone investment for over 10 years and qualify for the 0% capital gains treatment…if you have a gain on the investment.
That is not to say that there aren’t good opportunity zone investments out there. Just make sure it’s the right fit first, and don’t kid yourself into believing it doesn’t come with a lot of risk.