How Does a Qualified Opportunity Zone Work? Could I Benefit From It?

Wally Smith:
What, five, six years ago now, they came out with something called a QOZ. What is a QOZ?

Jeff Hertz:
Qualified opportunity zones was an idea that an individual named Sean Parker, who was the founder of the Napster file sharing or music sharing service back when I was in college in the early 90s, started and he was the first president of Facebook. He is, as they say, a serial entrepreneur and also a serial philanthropist. And so he had been running around this idea of encouraging people to invest into lower income areas, and by doing that giving them significant tax advantages. It was actually written into the Tax Cuts and Jobs Act, which went through at the end of 2017. To my point earlier, interestingly, that legislation also eliminated personal 1031 exchanges, as I mentioned earlier equipment and those types of things. So those types of exchanges for personal property were actually taken out.
The reason they were taken out is that the opportunities on legislation was so much broader, where you could invest gains from any asset sale into an opportunity zone investment or an opportunity zone program. So think a stock portfolio, a business sale, cryptocurrency, collectibles, real estate, almost anything with a gain, short or long term, can be invested into an opportunity zone. And for the purposes of this, let’s say they’re investing into a fund, just to keep it more simplistic, what that fund is going to do is they’re going to construct real estate assets in defined areas that were defined by that 2017 legislation. Quite simply what the treasury department did is they looked at the most recent census data from 2010, outlined areas that were lower income.
They then went to each of the 50 state governors and said, of the areas that exist within your state, you can outline 25% of these areas that will be designated as qualified opportunity zones, basically designating them as being areas where you can get the tax advantages of the program by developing an asset there. Quite simply what an opportunity zone investment allows you to do is to defer your capital gain for a period of time. Right now that timing is 2027. You would get to defer that capital gain until 2027. But much more importantly, any growth that you experience over the next 10 years in that investment, you can then take out tax free. It’s similar to a 1031 exchange, except the application is much broader than just real estate.

Wally Smith:
And so you’re only putting in the gains-

Jeff Hertz:
You’re only putting in gains. You get to keep basis.

Wally Smith:
So you get to keep your basis. In 2027, you do owe the capital gains taxes on those gains.

Jeff Hertz:
Correct.

Wally Smith:
So the structure of the opportunity zone investment has to, I think everyone I’ve seen provides liquidity of some kind or return of capital when it’s time to pay the taxes on that.

Jeff Hertz:
That would be the goal. I just, belt and suspenders, I would say don’t rely on that because the money changes and make sure that you have money available to pay the taxes in 27. But yes, that’s a common misconception that your gain, your original gain, that you get to step away from that. You get to defer it, but you do not get away from it. But what I refer to as the gain on your gain is working for you from day one in that fund. And again after a period of no less than 10 years, you can then take out your money out of the fund, and any growth you’ve experienced in the fund would be tax free.

Wally Smith:
Now, you said something interesting, I want to make sure that listeners or viewers catch it. The opportunity zones were based on what census?

Jeff Hertz:
2010. In the midst of the great-

Wally Smith:
Has it changed at all since 2010?

Jeff Hertz:
It’s almost a running joke, or I wouldn’t say a joke, but it’s a hobby of mine to find areas that were designated as opportunity zones that I do a lot of travel.

Wally Smith:
Which basically means that they’re beaten down and it’s lower level. Not necessarily slum lords, but we’re generally thinking Section eight housing or the blighted part of the town.

Jeff Hertz:
Or areas that are just in transition. Right? There are areas in major cities that are transitioning from being very heavy industrial to being more businesses and multifamily. Obviously here in Denver, like LoDo, there’s a lot of areas like that. Rhino. But the Houston Medical District, East Austin, where Apple’s building their new headquarters, downtown Los Angeles, we see a lot of urban areas that have been transitioning over the last now 13 years.

Wally Smith:
San Jose. Places in San Jose.

Jeff Hertz:
And even areas around college campuses, college students eat ramen and don’t make a lot of money. And so you can build buildings that are within blocks of college campuses where there is still great opportunity.

Wally Smith:
I don’t know the status of it now, perhaps you do, the recent attempts at legislation to say, okay, now let’s update it based on a current census essentially, or current areas. But they were also talking about extending, when it first came out, they had the 15%, the 10% rules as far as exclusion. Step up. Do you know, have they decided to continue that or to renew that or to extend it or modify it?

Jeff Hertz:
I should mention, because people, and I think you mentioned legislative risk on another topic, people want to make sure that this is something that isn’t going to be taken away. And obviously I don’t have a crystal ball. I don’t know if it could ever be taken away, but it’s important to note that the opportunities on legislation did in its inception and today enjoys bipartisan support also bicameral support. So the original architects of it, Corey Booker, and Tim Scott, a representative, Democrat and Republican co-sponsors of the bill.

Wally Smith:
Surprising bedfellows certainly.

Jeff Hertz:
Right.

Wally Smith:
They came together on this.

Jeff Hertz:
Ultimately 50 Republicans and 50 Democrats supported this legislation. There was a proposal last year to extend the deferral timeline, another two years out to 2029 to exclude certain high income areas to basically, to your point, back out some of those census tracks that no longer are considered lower income. However, if you already own and are developing right in an existing zone, you would get grandfathered in. There also is a proposal to potentially add back in that step up in basis. Because originally when this was introduced in 2017, it took two years for the treasury to issue additional rounds of regulations that clarified and quantified how we could-

Wally Smith:
There was a lot of confusion originally.

Jeff Hertz:
How a manager would operate one of these funds. But in order to entice early investors, there was at first a 15% step up. Then later a 10% step up, that went away a couple of years ago. There is talk of reintroducing that that step up as well.

Wally Smith:
But all that’s still just influx at this point.

Jeff Hertz:
It is. I think generally speaking, the perception is that the Republicans like the OZ program slightly more than the Democrats do. So maybe the shift in the house gives a little bit more weight to those potential changes.