Since its formation under the 2017 Tax Cuts and Jobs Act, the Qualified Opportunity Zone (QOZ) program has created a lot of buzz in the investment industry, especially with the significant tax advantages it may provide investors.
Investors should keep in mind the following six real estate investment tips before adding a qualified opportunity fund (or QOF) to their portfolio.
Be Prepared for the Long-Haul
Real estate investing requires a lot of patience and time. Successful real estate investors typically focus on assets that generate a steady income and will increase in value over time, also called capital appreciation. Many investors are willing to buy and hold property for long-term rewards. Similarly, qualified opportunity zone investments are specifically designed for the long-term. Any investor interested in a QOF should be willing to hold onto their investment for at least 10 years to potentially reap full tax benefits of the program.
Do Your Research
Investors should research the geographic area or areas around the qualified opportunities zone they are interested in. Understanding the surrounding communities, economic development, population growth and employment metrics will provide insight to the potential growth of the identified property or properties within the QOZ and its return on the investment.
Understand the Fund Strategy
It is important for investors to look for QOFs that have well-defined and proven strategies that contain specific details and data to back them. Fund managers should be able to clearly explain the types of properties to be developed by the QOF, along with how long the asset is expected to be held. Investors should also mindful of vague strategies that intend to invest anywhere and in any property type. Since certain properties have inherently different risk and return profiles, unfocused, or blind pool, strategies may end up making an investment in a higher risk property than expected by the investor.
Since the goal of a QOF is to hold the investment for at least 10 years, understanding the strategy behind the fund will help minimize potential surprises for investors.
Diversification is Key
Generally, investors should always be looking for ways to diversify their portfolio in order to reach long-term financial goals while minimizing risk. Real estate is a strong addition to many investment portfolios. By adding real estate, investors have the ability to increase their level of diversification by spanning various property types and geographic markets. Plus, real estate investments may provide investors a complementary source for returns and income.
Investments in QOFs are fundamentally real estate investments that may utilize a variety of strategies that range from single-property developments to portfolios with several properties in various markets. Investors in QOFs:
- Can maximize the level of diversification in their overall portfolio,
- May receive potentially significant tax benefits, and
- Hopefully, feel good about making a difference in the communities the QOF intends to invest.
Determined Risk Appetite
QOZ investors should know their risk appetite, or level of risk they are prepared to accept, before including a QOF in their investment portfolio. Since many of the properties a QOF invests in are ground-up developments, investors should have a level of comfortability with ground-up construction investments and the various unforeseen risks they may entail, such as budget overruns, zoning restrictions, environmental factors and more.
Pay Attention to Fees and Deadlines
Make sure the qualified opportunity fund of interest has fee structures that are fair and transparent. Currently, investors have until December 31, 2020 to invest their capital gains to take advantage of the QOZ program’s tax benefits. Ideally, seek out a qualified opportunity fund that has an asset, or assets, already identified or purchased.
While QOFs are a great way to expand an investment portfolio and help economically distressed communities throughout the nation, investors should keep these tips in mind and consult with a tax professional to make sure the strategy fits and aligned with their overall investment strategy.
Download our QOZ Fact Sheet from the resources area to learn more.
The qualified opportunities zone (or QOZ) program may provide substantial tax benefits for investors if certain tax requirements are met. These requirements include, but are not limited to adhering to, the defined QOZ timeline, holding the interest for a minimum length of time, and payment of taxes on the remaining originally deferred gains within the first quarter of 2027. It is important to note that all perspective QOZ investors should consult with and rely on a tax professional to review all of requirements and potential tax risks in depth prior to investing.
QOZ Risk Factors
There are substantial risks associated with the U.S. federal income tax aspects of a purchasing interests in a qualified opportunity fund. The following risk factors summarize some of the tax risks to an investor. All prospective investors are strongly encouraged to consult with and rely on their own tax advisors. The tax discussion here is not intended, and should not be construed, as tax advice to any potential investor.
- There is a lack of precedent and limited guidance related to qualified opportunity funds.
- A program intended to qualify as a qualified opportunity fund may not constitute a qualified opportunity fund for a variety of reasons, including a failure to substantially improve the property within the first 30 months of its operation. If a fund does not qualify as a qualified opportunity fund, then no deferral or elimination of taxable gain will be available to the its members.
- An investor must acquire his or her interest in a qualified opportunity fund on or before December 31, 2019 in order to receive a step-up in basis equal to 15% of the gain deferred by reason of the investment in the fund.
- Investors who hold interests in a qualified opportunity fund through December 31, 2026, and who have deferred gain through that time by acquiring such interests, will automatically recognize some or all of the federal income tax gain that they deferred on December 31, 2026.
- The state, local and other tax implications of a qualified opportunity zone investment are unclear.