Over the past several months, you may have heard the term “opportunity zone” in discussions about investing in real estate. The concept involves things that real estate investors really, really like — namely, low prices and tax breaks. That said, are opportunity zones worth pursuing? Are they all they’re cracked up to be?
Here’s what passive real estate investors should know about opportunity zones in real estate.
What is an Opportunity Zone?
Opportunity zones are not arbitrary. They aren’t decided by investors or the ebb and flow of the market. Instead, they are identified by governmental powers. According to the IRS:
“[An opportunity zone is] an economically distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as opportunity zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.”
On the surface, we see these distressed communities where home values are low, supply moves slowly, and employment rates are stagnant or unemployment is high. Because many types of real estate investors are looking to buy these types of distressed properties, the added bonus of a tax incentive makes investing in an opportunity zone seem like a no-brainer. But is it?
What does the law really say?
Whenever you deal in any sort of real estate transaction, be it a traditional acquisition or a 1031 Exchange, the fine print is paramount. Because opportunity zones are certified by the Secretary of the U.S. Treasury, there are certain guidelines not only in defining these zones but for the real estate investor to reap their benefits.
So what are the benefits, exactly?
The largest has to be the tax break. Investors are subject to 0% capital gains taxes in an opportunity zone...if they hold the property for at least ten years. This is a significant benefit if you intend to hold the property. Flippers, then, are out of the picture if they want that tax benefit.
Check out: A Quick Guide to Tax Benefits Every Real Estate Investor Should Know!
Not only that but when we look at the cost of these properties, we don’t see, on average, prices that are that impressive. Sure, they’re cheap — on average, 80 percent of properties in opportunity zones are below the national median price of $266,000. 47 percent comes in under the $150,000 mark.
The cheapest of these properties can be found in the Midwest, followed by the South and Northeast. Properties in the West, however, can be as expensive as $400,000 in an opportunity zone.
What do the critics say?
While originally designed to bring investment and value to distressed neighborhoods, critics of opportunity zones have expressed more than a few concerns. Chief among them is that, as investors “revitalize” these distressed neighborhoods, it doesn’t actually help the people who live there. As prices rise, residents are often pushed out of their neighborhood as gentrification takes hold.
Not only that, but the idea that capital is being poured into the community doesn’t always happen. Some agree that overall investment doesn’t increase and, by and large, residents don’t benefit from it.
Warnings for Real Estate Investors
The idea of an opportunity zone inherently sounds good. Cheap properties. Tax breaks. Passive income. However, there are some significant risks and pitfalls surrounding these opportunity zones.
The fine print is absolutely necessary when it comes to opportunity zones. Also called qualified opportunity zones (QOZ), the tax advantages therein come from the utilization of qualified opportunity funds (QOF). There are rules that go along with a QOF that make investing in a QOZ more restrictive. Among the guidelines?
- You must invest before year-end in 2019 to get the most tax benefits.
- More than 90 percent of your assets with a QOF must be investing in opportunity zones.
- Tax-deferred status is not indefinite. Deferment on capital gains taxes ends when the fund ends, when the property is sold, or on a hard deadline: at the very end of 2026.
This isn’t to mention the inherent risk of investing in a tough neighborhood and market. When employment struggles, so does the real estate market. You carry a lot of risk investing in these distressed areas that tax deferment may not balance it all out.
So What’s the Alternative?
For passive real estate investors, a 1031 Exchange carries many similarities to a qualified opportunity fund. Tax deferment is in the picture, though for 1031 Exchanges, taxes can be deferred indefinitely.
A 1031 Exchange offers more flexibility in where you invest as well. You can read more about 1031 Exchanges in our guide as well as in this interview.
At Memphis Invest, we guide investors through 1031 Exchanges often. It’s a great way to diversify your portfolio while reaping tax benefits.
The Best Option for Turnkey Investors
Self-directed investments are tricky. While we have the power and ability to invest in what we want, where we want, it can bring a lot of risk to the table. For inexperienced investors, things like opportunity zones might sound great on the surface. However, the advantages you have in turnkey real estate are far better. This is because you have the advantages of trusted, experienced professionals and teams combined with pre-vetted markets and neighborhoods.
If you want to build a stable portfolio, turnkey is the way to go.
Start earning passive wealth with a turnkey real estate portfolio!
