What are opportunity zones?
Opportunity zones captivate the commercial real estate industry, and not without reason. Opportunity zones are an investment vehicle whose purpose is to guide private investment to specific zones in need of economic development. The program was designed to target real estate investors and business owners within each opportunity zone. Opportunity zones were enabled at a federal level as part of the Tax Cuts and Jobs Act passed in 2017.
Who determines the opportunity zones?
Opportunity zones are defined by census tracts. The governors of each state and territory (plus the mayor of the District of Columbia) nominated census tracts within their jurisdiction that met low-income requirements as qualified by the Internal Revenue Code Section 45D(e). In some cases, census tracts with a different income profile than that laid for in Section 45D(e) could qualify if contiguous with a qualifying opportunity zone. In total, roughly 8,700 census tracts across the United States have been certified as opportunity zones.
What are the benefits of opportunity zones?
Opportunity Zones provide capital gains tax benefits that are not currently available through any other U.S. program. The system is designed in such a way that investors in opportunity zones can access three levels of benefit, depending upon how long they maintain their investment in an opportunity zone:
- Temporary deferral on initial capital gains: Investors may receive a deferral on the original capital gains tax until 2026* if capital gains from another investment are re-invested in an opportunity zone within 180 days of those capital gains being realized.
- Tax relief for initial capital gains: If the capital gains invested in the opportunity zone is maintained for 5 years, the investor can exclude 10% of the initial capital gains from the capital gains tax. If the investment exceeds 7 years, 15% of the initial capital gains will be excluded from the tax base.
- Permanent tax exclusion for any new capital gains: If the investment is maintained for at least 10 years, the tax on any appreciation of the investment during the period that it is invested in the opportunity zone will be waived permanently.
There is no maximum on how much capital may be invested by any single investor into the opportunity zones.
*The maximum deferral date is December 31st, 2026. If the opportunity zone investment is sold or exchanged before this date, the tax deferral period will end.
How do opportunity zones work?
Only Qualified Opportunity Funds (QOF) are able to invest in opportunity zones. Any investor wishing to invest in an opportunity zone will need to establish a QOF. A QOF is “any investment vehicle organized as a partnership or corporation that holds 90 percent or more of its assets in qualified opportunity zone property” (TaxFoundation).
QOFs must invest in Qualified Opportunity Zone Property. According to Fundrise, this is defined as:
- “Partnership interests in businesses that operate in a qualified Opportunity Zone.
- Stock ownership in businesses that conduct most or all of their operations within a qualified Opportunity Zone.
- Property such as real estate located within a qualified Opportunity Zone.”
It is this third bullet where the market expects to see the greatest level of investment. Investment in real estate for these purposes is primarily confined to “the construction of new buildings and the substantial improvement of existing unused buildings. If an Opportunity Fund invests in the improvement of an existing building, it must invest more in the improvement of the building than it paid to buy the building” (Fundrise).
How do opportunity zones relate to C-PACE?
One of the major remaining questions about opportunity zones is how they will interact with existing incentive programs. For C-PACE financing, this is a question easily answered. In fact, there is a clear synergy between the two programs thanks to their shared purposes to stimulate real estate investment and economic development.
C-PACE (commercial property assessed clean energy) financing is a form of construction finance that is repaid through a special property tax assessment. Property owners use C-PACE to access private capital that is earmarked to finance energy efficiency measures and/or renewable energy generation in new or existing properties. Therefore, C-PACE financing is one of the investment tools that QOFs could use to invest in an opportunity zone.
For more advanced information on how C-PACE and Opportunity Zones can be used in tandem to increase an investor’s return on capital, check out Cleanfund’s webinar on PACE in Opportunity Zones.
Where are opportunity zones in Maryland?
The Maryland Department of Housing and Community Development has established a website on opportunity zones in Maryland, including an interactive map showing where they are located and a lookup tool that allows the user to lookup whether a given property address is located within in opportunity zone. There are 149 census tracts in Maryland that are designated opportunity zones. To find out whether a property is located within and opportunity zone and eligible for C-PACE financing, please cross-reference the information on MDHCD’s website with the MD-PACE map of eligible C-PACE jurisdictions.
Click here for a list of opportunity zones in Baltimore City.
Click herefor more information on Montgomery County’s opportunity zones.