The Opportunity Zones program allows investors to gain capital gains tax benefits by investing in eligible properties and businesses located in specific, economically disadvantaged census tracts across the country, referred to as Qualified Opportunity Zones (QOZs). To gain the tax benefits of the Opportunity Zones program, an investor must invest in an Opportunity Fund, a special investment vehicle which needs to hold at least 90% of its assets in eligible property or businesses located inside an Opportunity Zone.

The benefits of investing in Opportunity Zones in commercial real estate include:

• Deferral of eligible capital gains until December 31, 2026
• A 10% reduction in their capital gains tax basis, provided they hold their investment for a minimum of five years before December 31, 2026
• A further 5% reduction in their capital gains tax basis if they hold the investment for a minimum of seven years

Investing in Opportunity Zones in commercial real estate carries the same risks as any other real estate investment. These include market risk, tenant risk, and interest rate risk. Additionally, there are some unique risks associated with Opportunity Zones, such as the risk of not meeting the requirements of the program, or the risk of not being able to find a qualified Opportunity Fund to invest in. Investors should also be aware that the tax benefits associated with Opportunity Zones are subject to change, and may not be available in the future.

The Opportunity Zones program, created as a result of the Tax Cuts and Jobs Act of 2017, is another way that commercial real estate investors can defer paying capital gains taxes on the sale of investment properties. The program permits investors to defer their capital gains taxes until December 31st, 2026, provided they reinvest their money into an Opportunity Fund. Opportunity Funds are specialized investment vehicles which must place at least 90% of their assets in qualified businesses or investment properties located in one or more of the 8,700 Qualified Opportunity Zones throughout the United States.

In addition to deferring capital gains taxes for up to 8 years, investors who hold their investments for a minimum 5 of years prior to December 31, 2026 can take a 10% reduction in their capital gains tax basis. And, investors who hold their investments held for a minimum 7 of years prior to December 31, 2026 can take an additional 5% reduction in their capital gains tax basis (for a total 15% reduction). To take full advantage of the program, however, investors must place their money in an Opportunity Fund before December 31, 2019.

In contrast to 1031 exchanges, investors aren’t limited to reinvesting funds from the sale of commercial property. Instead, they are permitted to reinvest funds from the sale of stock shares, the sale of a business, or the sale of other types of investments into an Opportunity Fund in order to defer their capital gains taxes.

To be eligible, a property must either be new construction, or if it is a rehabilitation project, the Opportunity Fund must invest equal or greater funds into property improvements than it did to initially purchase the property. However, a recent regulatory ruling posits that this only applies to the cost of the building, not the cost of the land. For instance, if an Opportunity Fund invested $1 million into an outdated apartment building, and it was found that the building was worth $600,000, while the land was worth $400,000, the Opportunity Fund would only need to invest $600,000 into property improvements, not the full $1 million. In addition, all construction or rehabilitation projects must be completed within 30 months.

For an Opportunity Fund to invest in a business, the business must not be in a prohibited category. Prohibited business categories include liquor stores, massage parlors, gambling-related businesses, golf courses, tanning salons, and several other types of “sin” businesses. Despite this, an Opportunity Fund can generally own property that is being leased to these businesses, they just cannot own shares in these types of businesses themselves. Plus, the business must do at least 70% of its business inside the Opportunity Zone in order to qualify.

The Tax Cuts and Jobs Act of 2017 requested that the governors of every US state and territory, as well as the mayor of Washington, DC) nominate specific, low-income census tracts in their area to become Opportunity Zones. In order to qualify, potential Opportunity Zones would need to have a minimum poverty rate of 20%, as well as a median income of no more than 80% of the statewide median family income (for rural areas), or no more than the greater of 80% of the statewide median family income or 80% of the median family income for that metropolitan area.

Investors can maximize their returns when investing in Opportunity Zones in commercial real estate by investing through an Opportunity Fund. Opportunity Funds must either invest in new construction or substantial rehabilitation of properties, to ensure the funds are actually being used to improve the area in question. In the case of building improvements, an Opportunity Fund needs to invest more in a building’s rehabilitation than it originally invested in the building’s purchase. In either scenario, all construction and rehabilitation work must be completed within 30 months of a property’s purchase. Additionally, investors can take advantage of a 10% reduction in their capital gains tax basis, provided they hold their investment for a minimum of five years before December 31, 2026. Investors may utilize a further 5% reduction in their capital gains tax basis if they hold the investment for a minimum of seven years.

Sources:

• The Top 10 Tax Benefits of Investing in Commercial Real Estate
• A Guide to the Opportunity Zones Program for Commercial and Multifamily Real Estate Investors

The best strategies for investing in Opportunity Zones in commercial real estate depend on the type of property you are looking to invest in. For office, retail, and industrial properties, borrowers will typically need to get commercial construction financing from a bank, which they then may wish to refinance into a fixed-rate CMBS loan, or, if the property is extremely high quality, a life company loan. Commercial real estate loans for multifamily properties are somewhat more diverse, as Freddie Mac®, Fannie Mae®, and HUD multifamily loans also become options (at least for rehabilitation and refinancing, as only HUD offers ground-up multifamily construction loans with their HUD 221(d)(4) loan program).

In fact, for properties utilizing the Low-Income Housing Tax Credit (LIHTC) program, Freddie Mac has a wide variety of financing products specifically designed to assist with this process, including Freddie Mac Bond Credit Enhancement with 4% LITHC, which provides forward commitments for both the new construction and substantial rehabilitation of LIHTC properties, and the Freddie Mac LIHTC Enhancement which insures investors against potential losses should an LIHTC-funded property owner default. Fannie Mae also offers LIHTC-focused products such as the Fannie Mae Credit Enhancement of Variable Rate Tax-Exempt Bonds (Index Bonds), which allows LTVs up to 90% for properties using 4% LIHTCs.

In order to qualify for the tax incentives offered by the Opportunity Zones program, investors must invest through an Opportunity Fund. When investing in real estate, an Opportunity Fund must either invest in new construction or substantial rehabilitation of properties, to ensure the funds are actually being used to improve the area in question. In the case of building improvements, an Opportunity Fund needs to invest more in a building’s rehabilitation than it originally invested in the building’s purchase. In either scenario, all construction and rehabilitation work must be completed within 30 months of a property’s purchase.