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How Are Opportunity Zones Affecting Real Estate Sales?

The Federal government created the Qualified Opportunity Zone (QOZ) program with the 2017 "Tax Cuts and Jobs Act." The program is meant to promote economic growth in struggling communities through tax incentives to investors.

U.S. states and territories, including Washington D.C., were able to nominate areas to be included in the QOZ program by census track last year. The U.S. Treasury and IRS recently finalized these selections. This program presents unique opportunities for real estate development and investment in the coming years.

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How Does the QOZ Program Work?

The goal of the Qualified Opportunity Zone (QOZ) program is to provide financial incentives to investors that make long-term capital investments in designated areas. Investors are required to invest through a qualified Opportunity Fund and can receive several types of benefits:

Capital gains that are reinvested will temporarily defer them for the sake of inclusion in taxable income.
Capital gains reinvested in an Opportunity Fund are awarded a step-up in basis.
Capital gains that are reinvestment into an Opportunity Fund and held for a minimum of ten years will be permanently excluded as taxable income.
According to the rules of the program, investors must re-invest funds within 180 days of selling a property to receive these benefits. The program is scheduled to end in 2026, but its benefits will continue until 2047. Investment properties must have a positive impact on the community, so this would exclude certain properties like country clubs and golf courses.

There are no statutory requirements on who can form an Opportunity Fund, but the fund must hold at least 90 percent of its assets in QOZ property, which can be tangible property, partnership interests, or stock used within a QOZ. In most cases, cash does not qualify.

Opportunity Funds can't just buy properties in these zones and hold them. There is a requirement that properties must be "substantially improved" during the period of ownership, which means that the owner's basis in the building (excluding the land) must be doubled.

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How Opportunity Zones are Impacting Real Estate Sales

The IRS has now approved Opportunity Zone designations for 8,700 of the 73,057 Census tracts in the U.S. California leads this list with 879 approved zones, but Wyoming has the highest percentage of census tract zones approved, at 19 percent.

These new approvals are expected to trigger a flood of fresh real estate deals and projects among commercial property investors. The new rules are supposed to unlock roughly $6.1 trillion in value sitting in some of this country's most challenged areas.

The requirement for "substantial improvement" of properties will be attractive for major repositioning and renovation projects. Some regulated lenders in this sector might be concerned with the constraints of the programs, which will provide additional opportunities for unregulated lenders.

Multifamily investors will be enticed by the long-term hold requirement of up to 10 years, since many favor longer-term investments for these projects. A large portion of multifamily projects are likely to be affordable housing, and investors that understand how to maximize state and local tax credits will be able to secure even more advantages.

The new QOZ program not only provides ways for developers to take advantage of tax savings but also new opportunities for lenders. This should create a surge in demand in the construction trades as well as commercial real estate and bridge loans to finance these projects.