What Is an Opportunity Zone in Real Estate?

An opportunity zone in commercial real estate is a census tract that provides capital gains tax cuts for those who invest in eligible properties within the district or tract. Opportunity Zones are just one result of the 2017 Tax Cuts and Jobs Act and are often called Qualified Opportunity Zones (QOZ).

Designated by individual states and certified by the US Treasury, QOZs were created to revitalize communities and encourage economic growth around the US. Because of this, these tracts are within low-income neighborhoods.

Opportunity Zones Pros and Cons

Investing in Opportunity Zones can save a commercial real estate investor thousands in capital gains tax. This is one of the most significant benefits of investing in these areas, but it doesn’t come without its challenges. There are also some drawbacks to be aware of before penciling this strategy into your overall investment plan. 

Pros of investing in Opportunity Zones in commercial real estate:  

• Opportunity Zones tax benefits: Investing in real estate opportunity zone properties is similar to performing a 1031 exchange. Once you sell an investment property, you’ll be liable to pay capital gains tax unless you re-invest the capital gains into a Qualified Opportunity Zone property. 

  At this point, your tax basis on the capital gains can be reduced or eliminated based on how long you hold the property. You can defer this tax until you sell said property or by December 31, 2026 – whichever comes first.

  • Holding the QOZ property for a minimum of five years will allow you to exclude 10% of the taxable capital gains you originally invested. 
  • Holding the QOZ property for a minimum of seven years will allow you to exclude 15% of the taxable capital gains you originally invested. 
  • And finally, holding the QOZ property for 10 years may allow you to permanently exclude both the 15% of taxable capital gains you originally invested, as well as all of the taxable capital gains of the Opportunity Fund.

• Improvements made on QOZ properties held: The fund must make improvements within 30 months such that it equals the property value when purchased.
• Lower purchase price: Real estate Opportunity Zones are based on a 20% poverty rate and annual family income of less than 80% of the area’s median income, making Opportunity Zone property often much more affordable than in other areas. Additionally, many of these areas see a significant appreciation rate, making for greater profit. 

Cons of investing in Opportunity Zones in commercial real estate:  

• Relatively ill-liquid, longer-term investment: For most investors, the greatest benefit comes if you hold the investment property for at least 10 years. If you have a shorter time horizon, you may want to crunch some numbers before deciding to go this route. 

• Potentially greater risk: Low-income neighborhoods typically have unsightly properties and are often correlated with higher crime rates. Although some areas may see a quicker turnaround as investors utilize the QOZ program, other regions and properties may be more difficult to sell later or find tenants once converted into a rental property. 

• Higher initial costs: The goal of the QOZ program is to rehabilitate neighborhoods, which takes capital upfront. You may not see profit or passive income for the first year or more until updates to the property are completed. 

If you’re new to investing, working with trusted real estate partners who have invested in Qualified Opportunity Zones can make the cons of investing in these zones a little less intimidating.

How To Invest in Opportunity Zones in Commercial Real Estate

To see the full tax benefits of QOZs, you should understand how to invest in Opportunity Zones in commercial real estate. The steps below will help you get started. 

• Locate a Qualified Opportunity Zone: The first step is to identify a property of interest within a QOZ or Qualified Opportunity Fund (which will be discussed further down). The Internal Revenue Service has a list of qualified Opportunity Zones. Alternatively, several maps exist to highlight these areas of the country. 

• Sell your existing asset(s) (when applicable): If the appeal of investing in an opportunity zone is to reduce your capital gains tax liability, you’ll first need to sell the asset associated with said capital gains. 

• Create or identify a Qualified Opportunity Fund: The IRS requires you to use Qualified Opportunity Funds to invest in Opportunity Zones. You can create these funds in partnership with other investors or self-certify if you’re solo. 
• Identify and purchase a property in your chosen QOZ within 180 days: Once you’ve sold your capital gains-heavy asset, you have 180 days to use those capital gains to close on an eligible property within an opportunity zone.

These steps are obviously simplified. Selling and purchasing property – any property – usually has nuances in and of itself, particularly when it comes to commercial investment opportunities. 

To ensure you close within the 180 allotted days, identifying a potential QOZ property before selling a previously held property can help expedite the process. Similarly, it’s a good idea to gauge interest in the property you’ll sell and identify how to make it a quick transaction. 

Utilizing a private money lender like Revolution Realty Capital can make purchasing a QOZ property quick and seamless. With a closing timeline of 10 days or less, you’d have time to purchase 18 different properties within the 180-day deadline (although we can’t say we recommend it). 

Who Should Invest in Opportunity Zones in Commercial Real Estate? 

Opportunity zone investing isn’t a sector suited for every commercial real estate investor. Those who will benefit the most are the investors with an investing horizon of at least 10 years. 

The longer the property is held, the better. This means that those with less than a 10-year time horizon might want to reconsider this type of investment. However, depending on your overall strategy, even holding an eligible property in a QOZ for five or seven years could still benefit you.

Opportunity Zones Map

Many states have created opportunity zone maps for locating these census tracts. To find these maps, simply Google “[INSERT STATE] opportunity zones map.” 

Alternatively, you can also locate Opportunity Zones across the entire US, including territories like Puerto Rico, using the following links: 

• US Department of Transportation Opportunity Zones map
• Novogradac Opportunity Zone Mapping Tool
• Opportunity Zones Map by OpportunityDB
• NMTC Public Viewer

This isn’t a comprehensive list, and some maps display additional data that can be useful for investors. We recommend evaluating all of the above-listed maps to get a better picture of areas with opportunity.

What Is a Qualified Opportunity Fund? 

The Internal Revenue Service describes Qualified Opportunity Funds as investment vehicles “organized as a corporation or partnership for the purpose of investing in a Qualified Opportunity Zone property.” In other words, a QOF is how investors purchase QOZ property. 

How To Create an Opportunity Zone Fund

To invest in QOZ property, you’ll need to create or locate a qualified opportunity fund and follow the requirements outlined by the IRS. Below is a simplified walk-through of how you can do just that. 

• Form a Business Entity: Whether with or without partners, first form an official business entity as an LLC, S corp, or C corp. For this part, you may need to work with a trusted lawyer or someone who has a solid understanding of the process. 

• Investors pool money to one fund (when applicable): If you’re working with partners, every investor will pool their money – capital gains from other properties or otherwise – into the fund.
• File Form 8996 annually: You’ll need to file Form 8996: Qualified Opportunity Fund with your annual tax filing paperwork. 

Creating an opportunity zone fund for commercial real estate endeavors isn’t too difficult – just make sure to safely house all your paperwork and contracts for later use if needed.

Qualified Opportunity Fund Requirements 

Once an opportunity zone fund is established, the said fund must meet specific opportunity zone requirements to see the full tax benefits of investing in an opportunity zone. 

• Established partnership or corporation: To invest in an opportunity zone, you’ll need to set yourself up as a business entity – even if you’re investing solo. Additionally, the establishment you organize must have the sole purpose of investing in Qualified Opportunity Zones. 
• Must hold 90% of assets in Qualified Opportunity Zones: For the IRS to recognize your QOF as a QOF, you must hold 90% of the fund’s assets in one or more Qualified Opportunity Zone properties. 
• Improvements made on QOZ properties held: The fund must make improvements within 30 months such that it equals the property value when purchased.

Opportunity Zone Funds can be a very lucrative vehicle for your investment portfolio, but only when you’ve followed the Qualified Opportunity Fund requirements the IRS has for utilizing them.

One of the best ways to get your QOZ project moving is to work with a hard money lender, like Revolution Realty Capital, to help fund the endeavor. This can be especially true if your interest lies in a property beyond what your already acquired capital gains will cover or if you don’t want all your funds held up in only one property. 

Whether you want to invest in an apartment complex or other commercial building, always do your due diligence on potential properties before committing your funds to a Qualified Opportunity Fund.