by Andrew Little, Special Correspondent
With the threat of fallout from Brexit, tariffs looming and interest rates rising, where should you put your money?
The answer for many today is into federal opportunity zone funds, which were created in last year’s federal tax overhaul.
A recently published directory of funds tracked by commercial real estate analytics company CoStar Group Inc. shows more than 110 funds taking money in and targeting qualified opportunity zone investments.
Stock and bond markets are extremely volatile, and many investors are selling their appreciated assets (taking chips off the table) to reinvest in a qualified opportunity zone fund. The unfortunate challenge is, to borrow the title from a 2012 indie movie starring Aubrey Plaza and Mark Duplass, “Safety Not Guaranteed.”
There are so many funds that it is hard to imagine they’ll be able to take advantage of the opportunity zone benefits while at the same time making sound investments.
Opportunity zone funds are set up to take in deferred capital gain money and invest it into businesses and business properties that are located in special census tracts selected by state governors across the country and certified by the U.S. Treasury as opportunity zones.
Opportunity zones have become a red-hot topic in commercial real estate circles as many of the designated areas are already red-hot and now certain money flowing into these markets also can get special tax treatment in three ways.
First, you are able to defer paying tax on any capital gain reinvested into a qualified deal for up to seven years. That gain can be on the sale of stock, property or a piece of art — anything that would otherwise be treated as a capital gain.
The second benefit is that by holding the investment for seven years, the basis gets adjusted upward by 15 percent, thereby reducing the gain you pay tax on.
The third and perhaps best benefit for commercial real estate is by holding the investment for 10 years. If you do so, you don’t have to pay any capital gains tax on the new investment. To clarify, you will have paid tax on your prior capital gain, but avoided tax on the new investment.
Back to the safety part. The program was established by Congress as part of the Tax Cuts and Jobs Act that passed in December 2017. The legislation takes about 10 minutes to read.
In mid-October, the IRS released a 74-page document intended to help interpret the two sections of code. More regulations are expected to be released by the end of the year, but the main characteristics should remain intact.
What started out as a simple idea to get money into downtrodden areas is taking on a life of its own, and the window is closing on the period to take maximum advantage of the benefits. The funds are ready to take money in, but the difficulty will be making both timely and decent investments into qualified property or businesses.
In the Richmond region, several of the designated areas were already benefiting from investment funds before the new section of code was written. Included in opportunity zones are Scott’s Addition, Shockoe Bottom, Libbie Mill, Regency Mall, Manchester, parts of Church Hill and the Arts District (north of West Broad Street downtown).
It is likely these areas will see the greatest flow of opportunity zone funds, but there are many other census tracts designated in the region.
While the benefits are quite good for investors looking to make long-term investments in exchange for deferring taxes for seven years, it would be prudent to invest in familiar areas and with a trusted source that is directly investing.
The consequences of investing into a fund that foolishly stretches to get dollars out the door are more negative than not making any investment in an opportunity fund at all. The trouble is being able to differentiate between the two.
As for the risk of Brexit and tariffs, one thing for sure is volatility is back. Gyrations over the past month created a wild ride in the stock market but also pushed spreads out on bonds and commercial mortgages from conduit lenders. The good news is Treasury yields fell off a cliff.
Rates are currently in the 4.05 to 4.2 percent range for 5- and 10-year loans offered by life insurance companies, according to the John B. Levy National Mortgage Survey. Conduit pricing is more expensive and ranges from 4.95 to 5.15 percent for 10-year loans depending on leverage.
John B. Levy & Co. partner and investment banker Andrew Little can be reached at firstname.lastname@example.org.