Originally published on Forbes.com.
I finally got around to getting excited about opportunity zones (OZ). My excitement subsided as I looked into the matter, but it still remains at a subdued level. The OZ concept regardless of whatever else it might be is an illustration of Reilly’s Third Law of Tax Practice –
(Note it is the third law of tax practice not planning.) Reilly’s Third Law of Tax Planning is –
Any clever idea that pops into your head probably has (or will have) a corresponding rule that makes it not work.
I quickly saw that law at work as I started scheming about opportunity zones and actually reading the statute popped most of the bubbles in my head.
There is a lot out about OZ, so what I am going to give you is my assessment – the boiled down version I have to give to a client or a more practical CPA. I will be glossing over the technical details. Don’t use this post to start your own OZ fund or evaluate one or prepare a return. What you will get here is my hit on whether you should be interested. Think of it as the Five Minute University explanation of OZ.
For Investors
Forget about it. It really doesn’t make much sense at all. If you find a good investment that happens to be OZ qualified, you might want to think about the election, but that’s pretty much it.
The OZ benefit to investors has unique attributes that make it seem attractive. Every capital gains deferral provision I can think of is measured based on proceeds. 1031 is probably the most well known. If you sell a property for a million dollars and have a hundred thousand dollar gain, you have to invest the whole million in your 1031 target to exclude the whole gain. If you invest less than $900,000 you get no gain deferral. Same sort of deal for corporate reorganizations. With an OZ election, you just need to reinvest the gain.
The other limitation common to capital gain deferrals is that it can’t be just anything that you sold just because you felt like selling. No such limitation with the OZ election. As long as it is a capital gain – long or short – you can elect to reinvest in an OZ fund.
On the other hand, the benefit is pretty meager – much too meager to get someone who reflects on it to shift to a qualifying investment if it is not a type of investment that they would normally make. A CPA I consult for, who is even more of a cynical bastard than I, summed it up this way.
OK. A client inquired about it I figured it was the same old invest in bad areas and bad people get a deduction or credit and lose your high-risk money.
I really abhor the “bad people” crack, but there is something to it. He was one of my earliest mentors and we worked on low-income housing deals in the early eighties, which despite all the pieties about sound investments worked on the strength of their tax benefits alone.
The benefit is that instead of recognizing your capital gain in 2019, you recognize it in 2026. And if you hold the investment long enough you can get as much as a 15% reduction in the gain. But that’s not all. If you hold on for ten years, you don’t recognize gain on the OZ investment itself.
A Simple Example
Let’s go with a 20% capital gains rate to make the math easy (Forget about NII and state tax and maybe it is a short gain). You sold something and had a $100,000 gain. Put aside $20,000 and you have $80,000 that you can do anything you want with.
Or you can take the whole $100,000 and put it into an OZ fund and make the election. Since you are a prudent person you need to find some money elsewhere so that you have $17,000 to pay out in 2027. Say $14,000. But remember, the tax will be based on capital gains rates in 2026, but capital gains rates never go up – well almost never.
Putting aside the possibility of a rate increase, but prudently reserving for the future tax it is really $94,000 that you could do anything you want with, that will buy you your $100,000 OZ investment. And at the point you make that deal how much is that OZ interest worth? If it is less than $94,000, consider Reilly’s Second Law of Tax Planning – Sometimes it’s better to just pay the taxes.
On The Other Hand
I interviewed Mike Novogradac, who, no kidding, is the CPA I most admire in the whole world. (I’ll explain that in some other post. I think I did the lower tier audit on a deal where his firm had the upper tier, but that was a million years ago and has nothing to do with my admiration for him). Mike’s eponymous firm ranks somewhere in the middle among the top fifty, depending on whom you ask.
Mike is much more upbeat about OZ. This may be related to the fact that he has built his firm around complex tax matters that involve a great deal of money. Novogradac is probably best known for its work on the low-income housing tax credit (LIHTC).
His minions ran numbers on an OZ investment that went the full ten years, qualifying it for all the goodies. The benefits converted an after-tax return of 6% to 9%. Bailing out after you qualify for the 15% reduction converts 6% after tax to 7.5%. I didn’t try to check those numbers, but they seem reasonable.
It is possible that by investing in an OZ you are buying low and that you have more upside to earn a strong pre-tax return, but the tax incentive is really not strong enough to shift my comfort zone.
For Property Owners
Now, this is where it gets exciting. Nobody listens to me so the OZ funds will be raising a lot of money. They already have. Here is a directory of funds.
It is up to the funds to be invested in qualified OZ properties. I’m not going to get into those rules, which are complicated and in need of even more regulatory guidance.
The funds can’t just buy businesses in OZs. They need to be creating something new. So if you have a great commercial property in an OZ, it might not be that exciting. If on the other hand, you have vacant land or something that needs substantial rehab, OZ designation has quite likely enhanced the value of your property.
So what you need to do is determine if your property is in an OZ, assuming that your phone is not already ringing off the hook with people telling you that it is. It takes a little futzing, but this map will allow you to enter an address and tell you whether it is an OZ. I have not checked it for accuracy, so use it at your own risk. OZs are defined in terms of census tracts, which are pretty small areas – essentially neighborhoods.
For Developers
This is like telling my grandmother how to suck eggs, but if your business is developing housing or commercial real estate, you should be aware that there is a pool of capital out there, that might make a project feasible depending on what side of the street it is on.
I spoke with a developer who was thinking about investing in a fund, because of a recent liquidity event, but is hanging back on that because of uncertainty about the 2026 capital gain rate. He told me that sites are already being promoted as located in opportunity zones.
For Tax Professionals
Because of the way it is likely to connect to financial statement issues, the tax work on OZ funds probably is pretty much a lock for CPAs. EAs and unenrolled preparers probably don’t have much opportunity except insofar as their clients invest in OZ funds or own property in OZs.
If you are early in your career, what is the percentage in becoming your firm’s OZ expert? It could turn out to be a dead end, but there is always the example of Mike Novogradac who took out a flyer on the historic credit and LIHTC and now runs a top fifty firm with his name on the door.
OZs are a temporary thing as the law now stands, but they have bipartisan support so they might have a much longer life.
I know that if I was still practicing, I would check the address of every property owned by every one of my clients and call up everybody who had anything in an OZ. It would not be hard to incorporate that with return prep.
For the most part, nothing would come of it, but people really appreciate that type of service. And as all those consultants for cost segregation will tell you, you don’t want your client to hear it from some other CPA and have them wonder why they didn’t hear it from you.
Good Policy?
Novogradac has an Opportunity Zones Resource Center that you should look at if you want more depth.
Here is our Vice President in a Breitbart story celebrating an OZ success story.
“After 11 years of abandonment, the Capital 8 theater is a reality. And it’s creating jobs and opportunity and energy in this growing community,” Pence said to applause. “Opportunity Zones help address unique needs by forming partnerships between the federal government with regard to tax benefits, state and local leaders, and local investors to create that incentive that makes it even more possible for people to invest at the point of the need.”
Joshua Pollard just posted something on this platform about IRS hearings on regulations.
Matthew Goldstein and Jim Tankersley have a story in the New York Times about the money that is already flooding into OZ funds.
Distressed America is Wall Street’s hottest new investment vehicle.
Hedge funds, investment banks and money managers are trying to raise tens of billions of dollars this year for so-called opportunity funds, a creation of President Trump’s 2017 tax package meant to steer money to poor areas by offering potentially large tax breaks.
Ahh. I smell tulips.