With the 2017 Tax Cuts and Jobs Act, the federal government was able to create a wealth-building vehicle for investors by giving them access to opportunity zone funds. This allowed for the improvement of struggling communities while also giving investors breaks on their capital gains tax. In other words, it gave passive investors a way to become wealthy while helping others.

What is an Opportunity Zone?

There are more than 8700 areas and projects throughout all 50 states and US territories that are considered to be “opportunity zones.” These locations often have abandoned properties that are in need of extensive upgrades. In cities, it might be a warehouse or factory in an area that used to do a great deal of manufacturing. And with these opportunity zone funds, investors can have access to the capital they need to renew these properties for different uses.

The program hopes that these initial investments will cause other investors to improve local properties. As these new housing projects get underway through an opportunity zone fund, investors may also redevelop grocery stores and other commercial ventures. Before long, entire regions may show signs of improvement.

How Do Opportunity Zones Work?

To do a major overhaul of a building, you need access to a great deal of capital. Properties will also need to meet the expectations of prospective buyers, so you will not only have to perform basic repairs but will also need new infrastructure.

That’s why opportunity zone funds aren’t open to every potential investor. Anyone who wants to participate must be an accredited investor who can meet a specific set of guidelines. Investors who want to access opportunity zone funding must have a net worth of at least $1 million or show proof that they generated an income of at least $200,000-$300,000 for two consecutive years. Fund managers will be looking for a buy-in of at least $100,000 because it increases their ability to make significant improvements on a property, but it will put this program out of reach for most investors.

The Advantages of Investing in an Opportunity Zone Fund

Investing in communities that are struggling financially may not be as appealing without certain incentives, which is why the legislation that established opportunity zones includes the following financial benefits.

Deferred Capital Gains

Capital gains tax is a frustrating part of building wealth. And the better your investments perform, the more you have to pay. Opportunity zones can give you a loophole that will allow you to defer some of your capital gains tax by using the money to generate a passive income. If you make an opportunity zone investment within 180 days of incurring capital gains, you can defer the taxes related to the investment amount until the end of 2026. That way, it can be used to generate more income before it goes to the government.

Reduced Capital Gains

It can take a long time to improve an opportunity zone, which is why the program awards investors who keep their money in the fund for an extended period of time. Although new legislation has been submitted, presently if an investor hold their investment for 10 years they can receive a 10% reduction in their capital gains tax.

Tax-Free Appreciation

If you keep money inside the fund for 10 years, any appreciation associated with the opportunity zone investment won’t be subject to capital gains. You still have to pay the capital gains tax on what you put in a decade earlier, but you won’t have to pay any more taxes on the profits you earned from the opportunity zone project.

The Risks Associated with an Opportunity Zone Investment

Every financial investment comes with a certain level of uncertainty, but it’s up to you to decide if generating a passive income is worth the potential loss. While opportunity zone funds can benefit both you and the community, here are some of the risks that are associated with these types of investments.

Untested Investment Model

Because this program has only been around since 2017, there isn’t an established track record for assessing the risks of making these investments. Developing a property in a struggling community is a commendable endeavor, but it won’t necessarily give you a high return. Even a well-developed property can have trouble finding tenants if it’s in a depressed area.

High Buy-In

Some investors will get uneasy about the size of the initial investment amount. For many people, a six-figure investment will make up most of their available wealth. And they may not be willing to tie up so much cash into a long-term investment.

Uncertain Community Investments

The purpose of an opportunity zone program is to create an investment that can benefit local communities while also getting a financial return. As the legislation stands, input from community leaders is not a requirement for the development process. Unpopular projects could be held back by legal challenges and protests. Without understanding the needs of people living in those areas, you may end up funding a project that will raise the cost of living and will gentrify a low-income area.

Is Investing in an Opportunity Zone Right for You?

If you meet the requirements for participating in an opportunity zone fund, you should first do your homework. Take the time to learn about all the projects that are looking for funds, as well as the backgrounds of all the managers and developers that are involved. The tax benefits of this program can be attractive to any investor, but you don’t want to lose money just so you can pay less in capital gains tax.

After you do some research, you might be able to find a project with a good chance of being successful. Investing in the right opportunity zone fund can benefit you financially, but it can also give you the chance to change a community for the better.

If you want more information on how you can make money by investing in real estate, be sure to get in touch with Trevor Shakiba at Shakiba Capital.