Federally designated opportunity zones in Harris County, Texas, and many other locations around the country offer the potential for serving the highest populated distressed regions in the Lone Star State. Spurred on by the 2017 Tax Cuts and Jobs Act, Houston is among the many areas quickly becoming desirable for real estate projects that encourage new businesses and job growth. According to the City of Houston, there are currently 99 zones designated as economically-distressed by the U.S. Treasury Department.
Investing in an opportunity zone is appealing to community builders, and it also provides attractive long-term tax incentives. Investors may defer capital gains tax on 1031 exchanges or profits from other investments such as stocks and bonds for at least five years if reinvesting their proceeds into opportunity zone projects. Profits generated from OZ projects, however, are tax-free after 10 years. While not every individual may wish to commit capital for that length of time, there are other important matters to consider.
The risks involved
As with any investment opportunity, there are risks and potential loss scenarios associated with an opportunity zone venture. According to CNBC, the new market has attracted many individuals who lack the necessary background or experience in real estate development. Projects should have plans designed toward developing properties in distressed neighborhoods that show strong potential for a turnaround or profitable sale.
Specialized investment vehicles intended for OZ development projects can be certified as a Qualified Opportunity Zone Fund. They must meet specific standards set by the IRS. Such a fund must hold at least 90% of its capital and assets in an OZ-qualified property and at least 50% of its income must come from an active trade or business. Failing to comply with IRS requirements may result in penalties or the fund losing the opportunity to take advantage of OZ tax savings.
While there has been a rush of private equity chasing OZ projects since passage of the new law, smaller developers can also capitalize on this new opportunity by investing directly or forming a Qualified Opportunity Zone Fund to raise money from accredited investors in a private offering.