An Opportunity Zone is an economically distressed U.S. community where investments can be eligible for preferential tax treatment. The federal government created qualified Opportunity Zones as a part of the Tax Cuts and Jobs Act of 2017 (TCJA) to encourage investment in these areas and spur economic development.
Because of the tax advantages offered in Opportunity Zones, they represent an attractive investment option. Learn some of the advantages of investing in Opportunity Zones, some barriers and risks to be aware of, and how you can get started.
How To Invest in Opportunity Zones in Two Ways
The primary way individual investors can invest in Opportunity Zones is through Opportunity Zone funds. According to the IRS, this type of fund, known as a Qualified Opportunity Fund, is “an investment vehicle that files either a partnership or corporate federal income tax return and is organized for the purpose of QOZ investing.”
These Opportunity Zone funds are primarily managed by large investment funds that invite affluent individual investors to join. The investment fund chooses the investments that it believes will provide the greatest return for the investors. These investments can include physical assets and ownership stakes in local businesses.
While investments in these funds aren’t necessarily limited to certain types of individuals, they often require a minimum investment of tens (or even hundreds) of thousands of dollars. However, the federal Opportunity Zone legislation doesn’t require a minimum or maximum investment.
There are nearly 300 Opportunity Zone funds across the roughly 8,700 Opportunity Zones around the country.
The other way to invest in Opportunity Zones is through an Opportunity Zone REIT. A REIT—or real estate investment trust—is a company that owns and operates real estate investments. Individuals can indirectly invest in real estate by purchasing stock in the REIT. This investment vehicle tends to have a lower upfront investment requirement than investing directly in an Opportunity Zone fund.
What You Need To Know Before You Invest in Opportunity Zones
The reason that Opportunity Zone funds are an attractive investment for those who can afford them is the tax benefits they provide. By investing in an Opportunity Zone through such a fund, investors can temporarily defer capital gains taxes. Once they sell an asset for a gain, they have 180 days to invest the money into a Qualified Opportunity Fund. If they do, they can defer capital gains taxes through 2021 or longer.
In addition to the tax deferral, investing in an Opportunity Zone allows investors to reduce their future capital gains tax by increasing their tax basis.
Capital gains taxes apply to the difference between the amount an investor sells an asset for and its basis—usually the amount they initially paid for it. Investors can increase their basis, and therefore reduce their capital gains tax burden by 10% or 15%, by holding their investment in the Qualified Opportunity Fund for five or seven years.
The stepped-up basis is available only to those investors who held their investment for five or seven years before Dec. 31, 2026. Therefore, to take advantage of the seven-year, 15% basis increase, an investor must have made their Qualified Opportunity Fund investment by Dec. 31, 2019. Investors also have until Dec. 31, 2021, to invest eligible gains to take advantage of the five-year, 10% basis increase that lasts until the end of 2026.
Finally, if investors hold their investment in an Opportunity Zone fund for at least 10 years, they can completely avoid paying capital gains taxes on their investment.
Federal regulations state that only gains recognized on or before Dec. 31, 2026, can be invested into Opportunity Zones and take advantage of the 10-year permanent exclusion. Because of the rule that gives investors 180 days to invest their gains, the deadline to invest in Opportunity Zone funds is June 30, 2027.
In exchange for the tax benefits they qualify for, Opportunity Zone funds have to meet a few requirements. Ninety percent of the fund’s investments must be in either physical assets located in an Opportunity Zone or an ownership stake in Opportunity Zone businesses. At least half of those businesses invested in must derive their overall incomes from an “active business” located in an Opportunity Zone.
Understand the Risks of Investing in Opportunity Zones
Despite the tax benefits that come with investing in Opportunity Zones, it’s also important to discuss some of the risks.
The first notable risk of Opportunity Zones is that they don’t necessarily benefit those they were designed to. According to the nonpartisan Center on Budget and Policy Priorities, Opportunity Zones are most beneficial to the wealthy investors who enjoy the tax breaks, and the zones are expected to lead to $1.6 billion in lost federal tax revenue over 10 years. The provision includes no requirements to ensure that local residents benefit from investments receiving the tax break.
As a result, most of the benefits likely won’t go to the people and businesses within the distressed communities.
In addition to the possible societal risks of Opportunity Zones, the individual investor will face some risks. First, every investment has its risks, and this tax-advantaged investment is no exception. Investors face the potential of losing the money they’ve invested.
Another risk of Opportunity Zone investing is the high minimum investment that’s often required. The investment funds that operate these investments often require individual investors to put up tens or hundreds of thousands of dollars to get into a fund. And for most investors, that simply isn’t feasible.
Pros and Cons of Investing in Opportunity Zones
Pros
Three potential tax benefits
Many funds to choose from
Propelling economic growth for distressed areas
Cons
High investment minimums
Long holding periods
Potential negative community impact
Pros Explained
- Three potential tax benefits: Investors can enjoy deferred capital gains when they invest the proceeds of a sale into an Opportunity Zone. They can also benefit from an increased tax basis and avoidance of capital gains taxes when they hold the investment for a certain amount of time.
- Many funds to choose from: There are nearly 300 Opportunity Zone Funds across more than 8,700 Qualified Opportunity Zones , meaning investors can choose one that fits their investing style or even benefits communities in their area.
- Propelling economic growth for distressed areas: The purpose of these Opportunity Zones is to spur economic development in economically distressed areas, which can benefit their residents by creating jobs or delivering other types of development.
Cons Explained
- High investment minimums: Many Qualified Opportunity Funds require investment minimums of tens or even hundreds of thousands of dollars.
- Long holding periods: You must hold your Opportunity Zone investment for at least five years to take advantage of the stepped-up basis, and for at least 10 years to avoid capital gains taxes altogether.
- Potential negative community impacts: There is some argument that these tax advantages benefit wealthy investors financing gentrification far more than the distressed communities the Opportunity Zones were designed to help.
How To Start Investing in Opportunity Zones
Are you considering investing in Opportunity Zone funds? Here are a few tips to follow to get started:
Research Opportunity Zone Funds
There are nearly 300 Opportunity Zone funds around the U.S. As a result, it will take some research to decide which to invest in. Some factors to consider when analyzing investments include:
- The minimum required investment
- The location and economic status of the Opportunity Zone or Zones that a fund is underwriting
- The type of investments the fund holds within one or more Opportunity Zones
Opportunity Zone funds present a unique opportunity to make a tax-advantaged investment that may also benefit an underserved community. Some investors may prefer to invest in an Opportunity Zone near them. But it’s also important to consider the fund’s investment strategy to ensure that it aligns with your own investment style, risk tolerance, and more.
Time Your Opportunity Zone Investment
One of the perks of investing in Opportunity Zones is that you can defer capital gains taxes on an existing investment if you reinvest your gains in one of these funds. But to take advantage of this tax benefit, you must reinvest your gains within 180 days of the sale. Be sure to time your sale so that you’ll be able to reinvest in the Opportunity Zone fund in time to qualify before the program is expected to expire. You can revisit the deadlines above to ensure your investment would qualify.
What To Watch Out for After You Invest in Opportunity Zones
As mentioned, you must hold an Opportunity Zone investment for a set period of time to fully take advantage of the tax perks. Because of these requirements, it’s important to plan your Opportunity Zone investment as a long-term one. But that doesn’t mean you need to simply set it and forget it.
Once you make your Opportunity Zone Fund investment, you can continue to track its performance. The investment company that manages the fund may provide updates about the underlying projects, which is important information to you as an investor.
Finally, when you decide to liquidate your holdings in the Opportunity Zone fund, be sure you understand the tax implications. Even if you’ve held the investment for the required 10 years to gain all the tax benefits, it’s important that you consult a tax professional to understand exactly what’s required of you from a tax and reporting perspective at the end of the holding period.
And if you don’t hold the investment for the full 10 years, it’s possible you’ll be on the hook for capital gains taxes, depending on your taxable income for the year. A tax professional can help you properly report and pay eventual capital gains taxes.
Should I Invest in Opportunity Zones?
Investors who will benefit most from these funds are usually high-net-worth investors—those with large capital gains they want to avoid being taxed on who also have considerable assets to invest.
That doesn’t necessarily mean the average investor can’t also invest in Opportunity Zones. But rather than investing directly in Opportunity Zone funds, you might consider an Opportunity Zone REIT that has a smaller upfront investment, more transparency, and greater liquidity, in case you need to access your money sooner.
Alternative Strategies for Investing in Opportunity Zones
Individuals who want to take advantage of this type of investment without the large upfront investment might consider an Opportunity Zone REIT instead. The minimum investment in an Opportunity Zone REIT is simply the price of one share of stock.
Some of the benefits of investing in an Opportunity Zone REIT rather than directly in an Opportunity Zone fund include:
- Your investment may be spread out across multiple Opportunity Zones, which can diversify your portfolio and reduce your risk.
- Opportunity Zone REITs may be liquid, so unlike with traditional Opportunity Zone funds, investors can pull their money out at any time. This may not be the case with all Opportunity Zone REITs, so it’s crucial to understand the restrictions before you invest. It’s important to note that withdrawing your investment early wouldn’t allow you to take advantage of the tax benefits of this type of investment, which is the primary purpose many people turn to them.
Unlike Opportunity Zone funds, some Opportunity Zone REITs may be publicly traded companies, meaning they have more transparency.
Frequently Asked Questions (FAQs)
How can beginners invest in Opportunity Zones?
You can get started investing in Opportunity Zones by researching which Opportunity Zone area or project you want to invest in, then reinvesting the gains from a previous investment into a qualified Opportunity Zone Fund, if you can afford the often-high minimum investment.
Do I need a lot of money to invest in Opportunity Zones?
Investing directly in Opportunity Zone funds often requires a minimum investment of tens or hundreds of thousands of dollars. But you can get started with far less money by investing in Opportunity Zone REITs.
What is the best way to invest in Opportunity Zones?
The best way to invest in Opportunity Zones largely depends on how much you can afford to invest. Affluent investors may prefer to invest directly in Opportunity Zone funds, while most individual investors are likely to find Opportunity Zone REITs a better fit.
