With most OZ funds, you must be an accredited investor? you must have a net worth of $1 million, excluding your primary residence, or have two consecutive years of at least $200,000 in annual income if you?re a single tax filer ($300,000 for married filers).
It can be structured as a partnership or corporation as long as the purpose is to invest in one of the Opportunity Zones? census tracts, through real estate or in businesses through equity. But remember, the fund must hold the bulk — 90% — of its assets in an Opportunity Zones area.
The lion?s share of qualified opportunity funds are going to be LLCs. Now it can be an LLC or a corporation or a partnership, but most will be an LLC that?s taxed as a partnership. So, one of the really important considerations is that when you set up your qualified opportunity fund you must have two members in it. And those need to be distinct members with separate employee identification numbers or taxpayer ID numbers.
A qualified opportunity zone fund is a private fund structured as a corporation or partnership that invests more than 90% of its capital into an opportunity zone. A recent ruling stated that a fund?s failure to meet the 90% asset test would not disqualify them from being classified as an opportunity fund but may result in a penalty.
Also, noteworthy, investors can use the proceeds from any appreciated asset. It?s not a requirement to invest with a like-kind asset to defer potential gains.
- Basis step-up of previously earned capital gains invested. For capital gains placed in Opportunity Funds for at least 5 years, investors? basis on the original investment increases by 10 percent. If invested for at least 7 years, investors? basis on the original investment increases by 15 percent.
What are the risks of investing in an opportunity zone?
As with any investment, there are risks with investing in opportunity zones. The largest is the viability of the investment in that zone. Just because there are tax incentives to place money in certain areas, it doesn?t mean every investment will be profitable. The location and type of investment matters. Look for a fund that has diversified assets across different opportunity zones.
Additionally, for investors to take full advantage of the tax incentives offered with opportunity zones, they need to roll a portion of their capital gains into an opportunity fund. This can reduce the diversification of the investor?s portfolio during this period, which can increase exposure to risk.
It?s too early to say what kind of gains, if any, these OZ funds will deliver, or which OZ funds are worthy investments. In fact, the rules on what an OZ fund can invest in and how it should operate are still evolving. That can pose a problem: An OZ fund must comply with a myriad of IRS guidelines. If it doesn?t, it may have to pay a penalty or, worse, the fund?s investors won?t be eligible for the capital gains tax breaks. Understand that distressed real estate deals are inherently risky.You?re buying into an area that people otherwise weren?t willing to invest in.
With little track record, inexperienced managers, high fees and a high hurdle to entry, OZ funds are not right for retirement savings or money you can?t stand to lose or lock up for the required holding periods. They?re geared more for deep-pocketed, savvy investors than mom-and-pop savers. If you?ve never invested in private equity or a closely held investment in which you?re a minority investor, these probably aren?t for you.
- Let more types of gains qualify for tax breaks. In perhaps the final regulations? most investor-friendly change, investors in businesses can defer taxes on more types of gains ? in particular, gains from the sales of certain business assets like real estate or heavy equipment. Under the tax code?s normal rules, businesses combine their gains and losses from the sales of these assets. Net gains from their sales in a particular year result in capital gains on which businesses pay capital gains taxes, and net losses let businesses take a tax deduction from their ordinary income. That means that businesses typically must wait until the end of the year to determine their overall gain or loss, and the proposed regulations would have followed that approach. Under the final regulations, though, businesses can calculate each sale on its own, giving them the best of both worlds: they can get the opportunity zone tax breaks for each gain, and they can get a full deduction for each loss.
- Let businesses hold cash for longer, making communities wait. To prevent investors from benefiting from opportunity zone tax breaks simply by keeping cash in the bank rather than putting the money into those communities, the law limits the amount of cash that a qualifying business can hold. But the proposed regulations included a generous exception, letting businesses qualify for the tax breaks even if they hold all their assets in cash for up to 31 months. Now, the final regulations expand this exception dramatically ? letting some businesses qualify for tax breaks without making any tangible investment in opportunity zones for more than five years.