What is an Opportunity Fund?
An Opportunity Fund is an investment vehicle specifically designed to facilitate into investment into designed low-income areas called Opportunity Zones. These funds allow investors to take advantage of a variety of tax incentives, including permitting them to defer their capital gains taxes until 2027. Opportunity Funds can be created by individual investors, who can place their own funds inside an Opportunity Fund, or by larger organizations, which can advertise these funds to private investors or to the general public.
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An Opportunity Fund is an investment vehicle specifically designed to facilitate into investment into designed low-income areas called Opportunity Zones. These funds allow investors to take advantage of a variety of tax incentives, including permitting them to defer their capital gains taxes until 2027. Opportunity Funds can be created by individual investors, who can place their own funds inside an Opportunity Fund, or by larger organizations, which can advertise these funds to private investors or to the general public.
What are the Requirements of Investing in an Opportunity Fund?
In order to take advantage of the capital gains tax deferral benefits of Opportunity Funds, an investor must place their money in a fund within 180 days of the sale of their assets. The fund itself must invest those funds in qualified assets within 6 months of receiving them from investors. Qualified assets include real estate and businesses located within a Qualified Opportunity Zone (QOZ). Funds may not invest in certain “sin” businesses, such as massage parlors, tanning salons, liquor stores, and horse-racing track. A fund needs to invest 90% of its funds in qualified assets, and will be subject to twice a year asset tests from the U.S. Department of the Treasury. -In addition, no more than 20% of the fund can be held by anyone financially affiliated with the fund (i.e. someone who has sold land or property to the fund in exchange for a partnership interest. However, the rules on this are still somewhat unclear.
What are the Benefits of Investing in an Opportunity Fund?
Investors who sell capital gains tax-eligible assets (i.e. stocks, bonds, real estate) and reinvest the funds in an Opportunity Fund can defer paying those capital gains taxes until April 2027. If they keep their investment in the Opportunity Fund for at least 5 years, they can achieve a 10% discount on their capital gains tax liability, while if they keep their investment in the fund for at least 7 years, they can achieve an additional 5% discount, for an overall 15% reduction in capital gains tax liability. Investments held in a fund for a least 10 years can avoid paying capital gains taxes on any profits generated from the Opportunity Fund itself.
What is the Structure of an Opportunity Fund?
Opportunity Funds can be structured in a few different ways. Generally, the fund itself is a partnership or corporation. While LLCs are usually allowed, single member LLCs typically are not. In many cases, a fund may wish to hold the property directly. In other cases, an Opportunity Fund may hold an interest in a partnership or corporation, which itself holds the property located in the Opportunity Zone. This joint venture/two-tiered structure allows for investors to reduce risk and pool resources for larger projects.
Related Questions
What is an Opportunity Fund and how does it work?
An Opportunity Fund is a partnership or corporation which plans to invest a minimum 90% of its assets in Opportunity Zones. Opportunity funds permit investors to avoid paying taxes on recent capital gains until December 31, 2026. If an investor keeps their money in an Opportunity Fund for at least 5 years prior to December 31, 2026, they will reduce their deferred capital gains tax liability by 10%, while if they keep funds in for seven years before that date, they can reduce their tax bill by 15%. In some cases, investors may even reduce their tax liability to zero on any profits they generated by investing in an Opportunity Fund, though they will need to hold their investment in the fund for at least 10 years in order to qualify. In addition, it’s important to realize that Opportunity Funds can self-certify, meaning that they do not specifically need to be approved by the government.
To be eligible, a property must either be new construction, or if it is a rehabilitation project, the Opportunity Fund must invest equal or greater funds into property improvements than it did to initially purchase the property. However, a recent regulatory ruling posits that this only applies to the cost of the building, not the cost of the land. For instance, if an Opportunity Fund invested $1 million into an outdated apartment building, and it was found that the building was worth $600,000, while the land was worth $400,000, the Opportunity Fund would only need to invest $600,000 into property improvements, not the full $1 million. In addition, all construction or rehabilitation projects must be completed within 30 months.
For an Opportunity Fund to invest in a business, the business must not be in a prohibited category. Prohibited business categories include liquor stores, massage parlors, gambling-related businesses, golf courses, tanning salons, and several other types of “sin” businesses. Despite this, an Opportunity Fund can generally own property that is being leased to these businesses, they just cannot own shares in these types of businesses themselves. Plus, the business must do at least 70% of its business inside the Opportunity Zone in order to qualify. This rule has caused serious concern for many Opportunity Funds, and is part of the reason why most initial O-Zone investments have gone toward commercial and multifamily real estate, not businesses.
What are the benefits of investing in an Opportunity Fund?
The main benefits of investing in an Opportunity Fund are threefold:
- Investors may defer capital gains taxes until they sell their investment or by December 31, 2026, whichever occurs first.
- Investors who keep their money in an Opportunity Fund for at least 5 years will receive a 10% reduction of their capital gains tax liability.
- Investors who keep their money in an Opportunity Fund for at least 7 years will receive an additional 5% discount, for a total 15% capital gains tax discount.
- Investors who keep their money in an Opportunity Fund for at least 10 years will not have to pay any capital gains taxes on any additional appreciation their investment has experienced since it was placed in the fund.
Source: Commercial Real Estate Loans
What types of investments are eligible for an Opportunity Fund?
Eligible investments for an Opportunity Fund include real estate or businesses located inside a Qualified Opportunity Zone. To be eligible, a property must either be new construction, or if it is a rehabilitation project, the Opportunity Fund must invest equal or greater funds into property improvements than it did to initially purchase the property. However, a recent regulatory ruling posits that this only applies to the cost of the building, not the cost of the land. For instance, if an Opportunity Fund invested $1 million into an outdated apartment building, and it was found that the building was worth $600,000, while the land was worth $400,000, the Opportunity Fund would only need to invest $600,000 into property improvements, not the full $1 million. In addition, all construction or rehabilitation projects must be completed within 30 months. For an Opportunity Fund to invest in a business, the business must not be in a prohibited category. Prohibited business categories include liquor stores, massage parlors, gambling-related businesses, golf courses, tanning salons, and several other types of “sin” businesses. Despite this, an Opportunity Fund can generally own property that is being leased to these businesses, they just cannot own shares in these types of businesses themselves. Plus, the business must do at least 70% of its business inside the Opportunity Zone in order to qualify. This information was sourced from Commercial Real Estate Loans.
What are the tax benefits of investing in an Opportunity Fund?
Investors who invest assets in an Opportunity Fund within 180 days of their sale may defer capital gains taxes until they sell their investment or by December 31, 2026, whichever occurs first. In addition, investors who keep their money in an Opportunity Fund for at least 5 years will receive a 10% reduction of their capital gains tax liability, while those who keep their investment in the fund for at least 7 years will receive an additional 5% discount, for a total 15% capital gains tax discount. And, investors who keep their money in an Opportunity Fund for at least 10 years will not have to pay any capital gains taxes on any additional appreciation their investment has experienced since it was placed in the fund.
Source: Opportunity Zones in Commercial Real Estate and A Guide to the Opportunity Zones Program for Commercial and Multifamily Real Estate Investors: How Opportunity Funds Work
How do I find an Opportunity Fund to invest in?
The best way to find an Opportunity Fund to invest in is to contact a commercial or multifamily real estate financing advisor. They can provide you with information about the different funds available and help you decide which one is best for you. Additionally, you can search online for Opportunity Funds in your area. Be sure to research the fund thoroughly before investing, as there are many different types of funds available and not all of them may be suitable for your needs.
For more information, you can check out the following resources:
What are the risks associated with investing in an Opportunity Fund?
Investing in an Opportunity Fund carries some risks, such as the potential for the fund to underperform or the fund manager to make poor investment decisions. Additionally, the tax benefits of investing in an Opportunity Fund may be reduced or eliminated if the investor does not hold their investment for the full 10-year period. Finally, investors should be aware that Opportunity Funds are not regulated by the government, so there is no guarantee that the fund will be managed properly.
Source: Commercial Real Estate Loans and Multifamily Loans