Across all 50 states and more than 600 low-income communities in Texas, real property investors are flooding these areas to reap the significant tax benefits of investing in a Qualified Opportunity Zone (QOZ). This new economic price support, which was added to the tax code by the Tax Cuts and Jobs Act in December 2017, is a bipartisan effort designed to enhance property value and stimulate job creation in distressed communities through tax deferral and gain exclusion.
One year after the Treasury Department designated the first set of opportunity zones, Jackson Walker partner John M. Ransom was featured in the Houston Chronicle podcast “Looped In,” hosted by Nancy Sarnoff and including Rebecca Schuetz, discussing the increasingly popular and complex topic of opportunity zones.
“There’s been a tremendous amount of interest – primarily from the real estate community,” John said. For the first time in his 40 years practicing tax law, John has received cold calls about technical tax questions. “Those folks are saying, ‘Is my property going to become more valuable because people who are deferring gain or potentially excluding gain will want to invest here as opposed to three blocks away?”
How Opportunity Zones Work
“Timing matters. You need to pay attention to the timing if you’re doing one of these,” John noted.
To reap the tax benefits of investing in an opportunity zone, there is a specific timeline to follow. For example, if John were to sell stock in Google and recognize a $1 million capital gain today, he has 180 days to roll that money into an opportunity zone fund. The fund then can invest in qualifying opportunity zone property or businesses. Such property needs to be new or, if used, substantially improved within 30 months after the purchase. In Texas, some prominent zones include the central business district of Houston, a sizable portion of downtown San Antonio, east of downtown Dallas, and the stretch along the south side of the Houston medical center.
The tax benefits include a deferral of the invested capital gain until the end of 2026 with a possibility of excluding 10-15% of such gain. More importantly, the appreciation on the original investment is tax-free if held for more than 10 years before sale.
“The clients I’ve talked to, the initial gain deferrals exclusion are icing on the cake, if you will,” John said. “What excites people is, using that example, the $1 million that I put into the fund and then properly invest it, if I wait at least 10 years to sell that investment, then the appreciation on the $1 million escapes tax totally.”
That means if the $1 million were to stay in for 11 years and appreciate to $2.5 million, that $1.5 million appreciation is not taxed – irrespective of what the tax rates are at that time, he added.
“People with patient money are pretty excited about that, and I think that is part of the social goal of saying, ‘Hey, look, this is not an in-and-out deal and property,” John said.
What Drives Interest in Multifamily Rentals
To take advantage of that tax-free benefit, investors are purchasing existing property, renovating the building to meet the tests under the rules, and attract capital from people who want to obtain the tax benefit. Primarily, John has seen investments in multifamily rentals, which allows people to remain with the investment for over 10 years by buying a building, renovating it, and turning it into multifamily and commercial leasing.
Investments can extend to anything from purchasing a bakery to purchasing existing software licenses and then rebuilding these particular licenses in an opportunity zone.
“The tax benefit is focused on tangible property, which drives jobs for people in these zones,” John added. “The thing about buying a business is it employs people. The biggest employers in America are small businesses.”
Where Investors Are Focusing Their Investments
Across the state in Austin, Dallas, Houston, and San Antonio, the real estate team at Jackson Walker has closed more than 40 deals for clients.
Recently, John represented a buyer looking at a location along a freeway. The buyer purchased property in an opportunity zone. Whether the buyer or the seller, both parties take advantage of the value provided by the opportunity zone designation.
“Both sides are saying, ‘I can command a better price, or maybe the property goes quicker. I’m more attractive than I was 14 months ago.’ Maybe it’s just a new suit of clothes, the property got dressed up, or the business got dressed up—it is more attractive,” he said. “Admirers – strictly ones that love saving taxes – are looking more, focusing their search within these zones.”
Ultimately, the hope of those who pushed this economic price support in the tax code was that opportunity zones would generate interest and redirect the flow of capital into these areas, which would in turn positively affect the community in a meaningful way.
“It’s hard to know how it’s going to play out, but it’s certainly refocused capital into these geographic zones,” John said. “If you believe that will have a collateral positive effect on the people living there, then it’s going to work.”
To read the full article and listen to the full podcast, go to Houston Chronicle’s article “Listen: Demystifying Opportunity Zones, Part I.” For more insights from Jackson Walker regarding QOZs and QOFs, view the following articles:
- “Brian Dethrow Analyzes Tax Benefits of Qualified Opportunity Zones” (July 30, 2018)
- “‘Dallas News’ Quotes Brian Dethrow on Tax-Backed Projects in Qualified Opportunity Zones” (October 2, 2018)
- “Treasury Releases Qualified Opportunity Fund (QOF) Guidance” (October 25, 2018)
- “Treasury Releases Additional Qualified Opportunity Zone Guidance” (April 26, 2019)
John M. Ransom chairs the Corporate & Securities practice in Jackson Walker’s Houston office. An experienced legal advisor and inactive Certified Public Accountant (CPA), John advises clients on various legal matters, including tax, mergers, acquisitions, financings, and management equity incentives. His practice experience involves counsel for closely held companies and their owners within the fields of manufacturing, services and distribution, aviation, and real estate, as well as tax counsel for oil and gas sector transactions. Since 2005, he has been recognized among The Best Lawyers in America in the area of Tax Law. He is a frequent author and speaker on business, tax affairs, and qualified opportunity fund investments.