Opportunity Zone Investments

Opportunity Zone Investments

By Don Chambers

The Federal government has created another giveaway program: opportunity zones. An opportunity zone is an economic region declared by state governments to be in need of external investment to stimulate real estate development and improvements. The Federal government encourages real estate investments in these zones by allowing tremendous tax advantages if 90% or more of the fund is invested in new projects in these blighted areas.

The tax advantages to investors are twofold: some capital gains tax deferral and some tax-free income. The tax deferral allows an investor who is selling an asset at a large capital gain to reinvest that gain in an opportunity zone and defer paying taxes on that gain for up to ten years.  Further, if the investment in the opportunity zone generates further profits some or all of that income may be tax free.

The income tax advantages are substantial. Here are the problems.

First, investors should be concerned that there is a reason that the opportunity zones need funds generated by this program: because the investment opportunities cannot stand on their own merits. Investors in opportunity zones may find that the favorable tax treatments cannot adequately offset the bad real estate returns.

Second, there is a lot of new money chasing these tax benefits and that money must be invested quickly because of a time limit on the program. The size of these capital infusions and the speed with which these investments must be identified and commenced could mean that a lot of the investments will be poorly selected and implemented.

Finally, this wave of inexperienced investors rushing into these private funds will likely be exploited by investment firms and their sales force. These investment firms are launching huge new private funds in their search to garner assets and generate high fees.  The potential tax benefits are likely to attract investors who will invest with firms inexperienced with real estate development. The private nature of the deals (rather than being subject to the regulation that comes with public trading) will lead to numerous cases of disastrous outcomes.

Some investors will reap great benefits from the combination of good underlying investments and nice tax benefits. But an unattractive portion of these deals will perform very poorly, leaving the unfortunate investors stuck in illiquid partnerships that will languish for years. Investor beware.

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