The Yellow Brick Road to Opportunity Zones

If you're an investor and don't know what an Opportunity Zone (OZ) is, you should. This legislation has been in place since 2017 and aims to increase investment in disadvantaged areas across the United States. As of 2022, the program has attracted over $100 billion in capital. While the current legislation has successfully attracted capital, it has specific deadlines. As we approach those dates, the tax incentives for investing in an OZ will diminish, ultimately expiring on December 31, 2026.

In September of 2024, a bill was introduced in the US House of Representatives to modify and extend the opportunity zone legislation. From what I'm reading and hearing, there appears to be significant bipartisan support for this bill. The proposed changes will include updates to the tax rules for investors and revisions to the locations of certified opportunity zones. Some very valuable changes have been proposed for investors.

Potential Rule Changes:

• Updated Qualified Zones. We should expect additional focus on rural areas and decommissioned military bases.  
• Create a Permanent Program that is revisited every 10 years to update the identified opportunity zones.
• Rolling Deferral. Taxes owed from your sale that serves as the OZ investment would be due five years from the investment date. It's a specific date, which makes the OZ less attractive as you get closer to the fixed date.
• Investment of Non-Capital Gains. Currently, only capital gains qualify. This is the most significant change that would allow ordinary income. The difference here is that ordinary income would not receive a tax deferral but would be exempt from future taxes on profits at the 10-year investment mark.

These are fantastic changes, but it doesn't mean all of an investor's focus should be on OZ.

Certified Economic Opportunity Zones

Source:  Economic Innovation Group

When evaluating real estate investments, look for those that pencil on their own and coincidentally happen to be located in an Opportunity Zone (OZ). The opposite, pursuing investments solely for the potential tax advantages, is a recipe for disaster.

Investors have to be willing to hold the real estate for 10 years. Investors typically analyze opportunities on a 4-7 year horizon. A decade is a long time, and a lot can change over 10 years, both to the market, the asset, and personally.

The taxes on your investable gains are still due. Under the current legislation, they are due December 31, 2026. If the new legislation passes, that fixed date will change to be five years from the investment date. Will your OZ investment be in a position to pay for the taxes that are coming due? If not, you're coming out of pocket. 

DXD has done one ground-up self storage OZ deal in our Fund II. It was a development where the returns did not need the OZ tax advantages to make it investable. It just happened to be in an OZ, which made it better. If this new legislation passes, expect DXD and many other developers to focus more on OZ deals.