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Opportunity zone investment: What physicians need to know about this option

Medical Economics JournalMedical Economics August 2021
Volume 98
Issue 08

And 10 questions to ask before you invest.

In 2017 Congress passed the Tax Cuts and Jobs Act which included legislation establishing Opportunity Zones (OZs) which created a win-win opportunity for distressed neighborhoods, real estate developers and many investors. The underlying concept of OZs is to promote long term economic development in distressed areas by providing incentives for investors and real estate developers to revitalize these areas by constructing new residential or commercial buildings which in turn attract residents and businesses.

Communities and neighborhoods are the first to benefit from being designated as an opportunity zone. To be in one, the area must be designated by its state and approved so by the IRS. To date there are nearly 9,000 qualified opportunity zones in the U.S. which makes investment and development opportunities available throughout the country. An internet search will quickly provide a list of these zones and their locations.

Real estate developers also win because they have a clear incentive to undertake OZ construction and renovation projects. They can create OZ funds to attract investors and use to funds to finance their OZ projects. Then they are able to earn revenue from the rental or sales of these properties as well as from management fees paid by investors. In some areas, additional state or community funding for those specific projects is also available to the developer. These projects provide employment opportunities and generate purchases as these projects are completed.

Individuals who have realized taxable capital gains from the sale of other assets also win with OZs. The 2017 legislation permits individuals who meet the accredited investor criteria to invest their capital gains in OZ funds within 180 days of realizing them. In turn, they can defer the income taxes on those capital gains until 2026. For example, assume an individual makes a $100,000 investment of some type and sells it later for $500,000 resulting in a capital gain of $400,000 and creating a capital gain tax liability of $80,000 (assuming a 20 percent capital gains tax rate.) By investing that same $400,000 in a qualified opportunity zone fund the $80,000 tax burden is deferred until 2026. If the investor remains in the fund for 10 years, there will be no tax on the additional income earned from the fund. Most fund sponsors do charge investors a management fee. They may also guarantee investors a specific rate of return and may charge a fee if the total return exceeds the guaranteed amount. The specific length of time each individual’s money must remain in the fund and the tax impact when it is withdrawn should be discussed with a financial advisor or fund sponsor.

There are more than 230 OZ funds available to potential investors. They differ in terms of the opportunity zones being served, the types of construction or renovation projects being undertaken, the past experience of the fund sponsors, and the minimum investment levels required. Typical investment minimums can range from $25,000 to $100,000, with some funds requiring a minimum investment of $250,000, or even $1 million. A list of these funds can be found with a simple internet search.

The accredited investor term mentioned above bears explanation. As defined by the Securities and Exchange commission, an accredited investor is one that can accept investment risk. To qualify, a single individual must have a net worth of $1 million, excluding a primary residence or show two consecutive years of an annual income of $200,000. For a married couple that income threshold is $300,000.

Some funds are developing large multi-family residential or commercial office buildings while others are building schools, storage units, student housing and medical facilities to name a few. Not all focus on new construction. Some choose to renovate existing buildings in an opportunity zone. Those choices are often based on the size of the fund and the economic and cultural needs of the opportunity zone and surrounding areas. It’s common to find large funds undertaking projects in multiple cities or even across states while smaller funds may focus all their activity in a single opportunity zone. Clearly the size and scope of these projects determine the amount of money the fund must raise, and the time required for it to begin generating revenue for its investors.

The tax advantages of opportunity funds for investors are much the same for all funds. What differs are the returns being promised to investors, the economics and demographics of the opportunity zones they have targeted, the size and scope of the projects they undertake, their experience and success with those types of projects, additional local or state funding that might be available, the time required to generate a return on the properties and their communications with their investors.

It makes sense for investors facing a substantial capital gain, with their financial advisors help to conduct their own due diligence to identify opportunity zone funds that appeal to them. Most have web sites and social media sites which will provide a wealth of information and can answer some of the questions that should be asked such as:

1. In what locations (city, state and/or specific opportunity zone) will the fund be active?
2. Why / How did these locations warrant an opportunity zone designation?
3. What is the relevant social, economic and business history of those locations?
4. How will the fund’s real estate interests impact these locations?
5. What specific type of real estate does the firm have or will it create on those sites?
6. If some new, renovated property has been completed, what is the sponsor’s track record on occupancy or sale?
7. If these are renovation properties, what is the firm's experience in this type of development?
8. What is the minimum investment?
9. What is the sponsor’s communication program to keep investors up to date?
10. What investment return does the sponsor project.

The creation of Opportunity Zones and OZ funds combined with the support of investors and the ingenuity of developers will result in significant improvements in communities nationwide.

John Blachford is the founder of Kunst Real Estate an opportunity zone sponsor headquartered in Cincinnati, Ohio. Through its opportunity funds the firm purchases, renovates and manages 100-year-old apartment buildings in the city’s Over The Rhine neighborhood which is a designated opportunity zone.

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