Depending on their tax bracket, investors in California are required to pay anything between one and 13.3 percent in state taxes, as well as 0, 15 or 20 percent in federal taxes on investments that are held longer than a year. And all of that adds up. But here’s the good news: There’s now a way to defer taxes on capital gains for 10 years — by investing in opportunity zones.
What Are Opportunity Zones?
Senators Tim Scott (R-SC) and Cory Booker (D-NJ) proposed the bipartisan U.S. Investing in Opportunities Act in February 2017. As a result, in December 2017, opportunity zones were added to the tax code when the Tax Cuts and Jobs Act was signed into law. Opportunity zones are designated census tracts in economically distressed communities where investors enjoy certain tax incentives — under specific conditions.
Investors that want to take advantage of opportunity zones have to commit to a long-term investment of 10 years to qualify for the tax incentive, which is the elimination or deferral of capital gains taxes, according to the Los Angeles Economic & Workforce Development Department. In general, there’s considerable flexibility in the types of investments that qualify, for example, smart buildings, commercial properties, and affordable housing.
As the IRS explains, qualified opportunity funds are the investment vehicles for investing in opportunity zones. They’re set up as either corporations or partnerships in order to invest in eligible property. It’s important to note that investors don’t have to live in an opportunity zone to invest in it.
Opportunity Zones in California
BisNow reports that in California, there are currently 879 tracts that are designated as opportunity zones — the highest number in the nation. And unsurprisingly, property values in those zones have increased by as much as 20 percent over the last year, thanks to the deferred tax or tax-free nature of the investments and their potential to transform low-income areas.
You can find a list of designated opportunity zones at the Community Development Financial Institutions Fund website, and you can see a map of the incentive areas in Los Angeles here.
Work With a Qualified Real Estate Agent to Find Property in an Opportunity Zone
If you’re interested in investing in an opportunity zone, you need to file IRS Form 8996 along with your federal tax return. Then, once you’ve formed a qualified opportunity fund, you can search for property to invest in. And it’s during this step that it’s critical to work with an experienced real estate agent who possesses in-depth knowledge of local opportunity zones — and their potential.
In essence, a viable project is one whose fundamental characteristics are already set it up for success — even without the tax incentive. In short, the property needs to meet all necessary requirements for the project, the developer should possess extensive experience working on this kind of development and the project should be realistically set up to be completed within a specific timeline in order to generate revenue within the desired amount of time.