What is the Opportunity Zone Program?
The Opportunity Zone program was created by the Tax Cuts and Jobs Act passed in December 2017. The driver behind the Opportunity Zone program was a focus on addressing the uneven economic recovery of certain census tracts following the housing market crisis in 2007-2008, and the goal of the program was to connect an estimated $6.1 trillion dollars in unrealized private capital gains to accelerate recovery in those communities. In other words, the program uses private sector equity investment to target growth in certain statistically distressed communities.
What are Opportunity Zones and How Were They Selected?
While there has been much debate regarding the selection process of which communities would be designated Opportunity Zones, the federal government created the process with local communities in mind. Following the passage of the law, each state governor was given the power to nominate up to 25% of the census tracts in that state in low-income communities to be designated as Opportunity Zones. Following the nomination by each state governor, the U.S. Secretary of Treasury reviewed all nominations and gave the final designation to the 8,764 census tracts that then became designated as Opportunity Zones.
Opportunity Zones are by-design not the most distressed areas. The federal government gave the nomination power to the local leaders as they believed those individuals would not only know which areas needed aid in recovery, but also those areas in which they believed private investors would be willing to make long-term investments. Because of this balance that state leaders had to consider, some areas that were already recovering were selected, while some areas that have been more neglected were not.
How Does the Opportunity Zone Program Work?
The Opportunity Zone program allows a taxpayer who recognizes a capital gain to defer the tax associated with that gain, and potentially eliminate a portion of the tax owed by investing capital gains into what is known as a Qualified Opportunity Fund. Generally, a taxpayer has 180 days from the date of the sale or disposition that gave rise to the capital gain to make an investment into a Qualified Opportunity Fund; however, special rules may apply in certain circumstances, to allow more time.
The Qualified Opportunity Fund is an arms-length investment vehicle that has been created for purposes of using the program. Investment into a Qualified Opportunity Fund is an absolute prerequisite to being able to utilize the program. Most investors establish an Opportunity Fund that is specific to a deal they are working on, while others may choose to invest in large Qualified Opportunity Funds that target multiple investments. The Qualified Opportunity Fund then makes investments with its assets into what is known as Qualified Opportunity Zone Property, which property must compose 90% of the Qualified Opportunity Fund’s assets, in order to remain compliant.
Qualified Opportunity Zone Property could also fall into one of the following categories: (1) Qualified Opportunity Zone Stock; (2) Qualified Opportunity Zone Partnership Interest; or (3) Qualified Opportunity Zone Business Property. This allows the Qualified Opportunity Fund to be able to either hold a real estate asset directly, or it may choose to hold an interest in a lower-tiered entity (known as a Qualified Opportunity Zone Business) which holds the real estate asset. Both of those structures have their benefits and drawbacks, and the determination of how best to structure a deal must be carefully considered.
The Qualified Opportunity Fund and Qualified Opportunity Zone Business then manage the investment similar to how they would any investment. Of course, there are certain requirements that must be met and ongoing reporting that must be accurately documented. However, now that the final Regulations have been issued, investors can move forward with a clear understanding of how to see returns on their investment through to ultimate disposition. These additional requirements must be considered on a case by case basis, and the particular requirements that will apply to a taxpayer’s investment will largely depend on how the investment has been structured.
What are the Benefits?
The Opportunity Zone program provides three statutory tax incentives to encourage long-term private investment into those targeted geographic areas. Those three main benefits are:
- Temporary deferral of capital gains tax;
- Partial capital gains tax avoidance due to a step-up in basis on the deferred capital gain; and
- Permanent exclusion of capital gains tax due to appreciation on the taxpayer’s investment.
The first benefit allows a taxpayer to temporarily defer from the taxpayer’s taxable income the amount of tax that would have otherwise been due on a capital gain when the taxpayer reinvests capital gains into an Opportunity Fund. The deferral of the capital gain invested into an Opportunity Fund will last until the earlier of either of when the investment is sold (or exchanged) or December 31, 2026.
The second benefit allows an investor to increase the cost basis in the investor’s deferred capital gain depending on the length of time that the investment is held in the Qualified Opportunity Fund. Investments held for at least five (5) years are permitted to increase the cost basis to result in a tax savings of 10%, and investments held for at least seven (7) years are permitted to increase the cost basis by an additional 5%, for a total capital gains basis increase of 15%. However, because the latest the tax on the deferred gain will be due is December 31, 2026, investments can only receive the additional 5% increase if the investment was made prior to December 31, 2019. Assuming the capital gains tax remains consistent, the percentage increase in cost basis will equal the amount of tax savings from the second benefit.
The third benefit is arguably the most beneficial for taxpayers making use of the Opportunity Zone program, as it allows for the permanent exclusion of appreciation on the taxpayer’s investment. What this means for investors is that the basis in their investment is increased to the fair market value of the investment on the date that the investment is sold or exchanged, which could result in large capital gain tax savings. This rule is only applicable for investors who hold their deferred investments for at least 10 years, which goes back to the long-term goals of the Opportunity Zone program.
Ohio’s Complimentary Opportunity Zone Law
Ohio was one of the first states to pass a complimentary Opportunity Zone law and has one of the most favorable incentive programs for investors. House Bill 166, which created Ohio’s complimentary incentive program, passed the Ohio General Assembly on July 18, 2019 and became effective on October 17, 2019. The Ohio incentive provides for a state income tax credit in the amount of 10% of the total amount an Ohio taxpayer invests into a Qualified Opportunity Fund that invests solely into one or more Ohio Opportunity Zones.
This tax credit is capped at $1,000,000 per taxpayer, and the State of Ohio has allocated $50,000,000 to be awarded to investors making use of the program, both per two-year cycle. In its first year, Ohio taxpayers were awarded approximately $30,000,000 in tax credits, and the demand for this program is expected to rise in future years.
Sikora Law has was involved in finalizing the language of Ohio’s law and advocating for its passage, including providing testimony to the Ohio General Assembly in support of the Bill. These efforts have made the Sikora Law team experts on how to make the most of Ohio’s Opportunity Zone law.
Sikora Law’s Opportunity Zone Services
Sikora Law’s Opportunity Zone attorneys can cover all of your Opportunity Zone investment legal needs. Our team of lawyers has structured over $250 Million in Opportunity Zone real estate investment deals, and has played a consulting role in an additional $250 Million real estate investments deals. Our Clients were awarded approximately 20% of all of the Opportunity Zone tax credits issued by the State of Ohio, more than any other firm. If you have a need related to Opportunity Zones, Sikora Law can assist you well, from investment to disposition.
Sikora Law offers the following Opportunity Zone legal related services:
Qualified Opportunity Fund Formation:
- Fund creation, operation, and compliance
- Timing strategies for deployment of capital
Company Organization & Tax Compliance
- Structuring of entities to utilize Opportunity Zone program
- Drafting of company Operating Agreements to comply with Opportunity Zone law
- Advising clients on applicable federal tax forms necessary for annual filing
Financing & Securities:
- Advising clients on equity financing, multi-source financing, non-traditional debt, and other governmental incentives
- Drafting documents for capital raise compliance and offerings
- Connecting clients to lending sources and private investors
Project Development for Real Estate Investments:
- Equity, debt, and financing structuring for real estate acquisitions and development
- Drafting real estate purchase and sales agreements and entity purchase and sales agreements
- Legal guidance related to target asset selection, acquisition, and due diligence review
- Drafting and reviewing lease agreements and property management agreements to comply with Opportunity Zone law
- Gravity 2.0 – Columbus, Ohio
- Scioto Peninsula – Columbus, Ohio
- Battery Park Marina – Sandusky, Ohio
- Bluestone Business Center – Euclid, Ohio
- Pro Football Hall of Fame Village – Canton, Ohio
Opportunity Zone Attorney Contacts
If you have questions related to how Sikora Law’s Opportunity Zone attorneys can guide you through your real estate project, please contact our experienced attorneys today. Additionally, if you would like to know whether a site you are considering is in an Opportunity Zone, then please visit an Opportunity Zone Map located here.