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Are Opportunity Zones truly a good opportunity?

On paper, Qualified Opportunity Zones are a win-win. Investors capture capital gains by deferring the tax hit. Economically depressed areas receive a booster shot of capital. More wealth. More jobs. Everybody’s happy, right?

But Opportunity Zone investments have significant risks. Possibly much more risk than simply playing the stock market. In addition to your financial advisor, a real estate lawyer can help you determine if the tax incentives justify the potential downsides.

Opportunity Zones are a valid strategy to preserve capital gains

The Tax Cuts and Jobs Act of 2017 created Opportunity Zones as an economic development tool. Investors who have recently realized capital gains can reinvest those gains – tax-deferred -- into qualifying businesses and commercial properties within designated zones. The investor is able to put a larger share of their gains to use. The economically distressed community benefits from the outside infusion.

The system is built to reward investing for the long term:

  • The initial capital gains taxes are deferred until Dec. 31, 2026 (or exit from the Qualified Opportunity Fund, whichever is first) .
  • The tax rate on those initial gains is reduced by 10 percent at the five-year mark and by another 5 percent at the seven-year mark.
  • If the investment is held for at least 10 years, no capital gains taxes are charged on the fund’s appreciation during that span.

Are there Opportunity Zones in New Jersey?

Yes, state officials identified 169 tracts in low-income areas, and those were certified in April 2018 by the U.S. Treasury as Qualified Opportunity Zones. There are eligible zones throughout New Jersey, including pockets of Somerset, Middlesex and Hunterdon counties. While many “O-Fund” investors intentionally support their local economies, it is not strictly necessary to reside in the community or county where the Opportunity Zone is located.

So what’s the catch?

Investing in development projects and commercial real estate in low-income areas has always been a gamble. It typically takes a certain critical mass of investment, in conjunction with local government leadership, to “raise all boats” and produce a corresponding return for investors. The program specifically targets distressed communities with high poverty and unemployment, which are the hardest to turn around. For some investors, holding on for five, seven or 10 years to capture the capital gains tax benefits is offset if the fund under-performs (or folds).

Because the program is still so new, there are many unanswered questions about the rules and regulations. While many experts are bullish on Opportunity Zones, other real estate gurus are reserving judgment to see how the realities shake out and what the hiccups or barriers may be. If everything goes right, Opportunity Zones can easily outpace returns in the stock market. But any given Opportunity Zone investment could be a total bust.

There is also a time limit

Capital gains must be invested within 180 days of the transaction into a Qualified Opportunity Fund, which is a corporation or partnership created specifically for the Opportunity Zone program. Because of the many legal nuances and unknowns, you should involve legal counsel, and in timely fashion to cross all the i’s and dot the t’s before the deadline. A real estate attorney will also be more familiar with market values and overall development trends within the zone.

The Law Office of Rajeh A. Saadeh, L.L.C., does not specifically endorse Opportunity Zones over other real estate investments, or over other tax-deferral strategies such as 1031 exchanges. We are happy to explore the pros and cons of this investment vehicle with you. If you decide it makes sense, our lawyers would help set up the O-Fund properly to protect your personal interests as well as your business partners or co-investors.

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The Law Office of Rajeh A. Saadeh, L.L.C.

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