How To Choose the Right Opportunity Fund for You
Carl E. Sera, CMT
March 5, 2023
The year 2017 marked a turning point in taxes—the Tax Cuts and Jobs Acts established a tax rule allowing investors to defer their capital gains taxes. In addition, it allowed them to reinvest their capital gains into Qualified Opportunity Zones via Opportunity Funds. But what exactly are Opportunity Funds, and are they right for you?
Before jumping into Opportunity Fund Zones, clients must consider long-term investment goals. Clients then select a Qualified Opportunity Fund (QOF) that aligns with said goals. This opens up opportunities for reaching your financial goals. So let’s review what Opportunity Funds and Zones are and tips for choosing the best ones for your desired financial results.
What Are Qualified Opportunity Funds and Zones?
Qualified Opportunity Funds are investment vehicles designed to invest in business developments or real estate in Opportunity Zone areas. Opportunity Zones focus on specific geographic areas designated to different economic regulations than other country or state regions. Therefore, tax incentives for investments in Opportunity Zones include potentially reduced and delayed taxes on capital gains.
Opportunity Funds came about as a part of the 2017 Tax Cuts and Jobs Act (TCJA), encouraging investment in underfunded, distressed, and low-income communities. The state must designate communities classified as Opportunity Zones, and the secretary of the US Treasury must subsequently certify them via the IRS. Then, a partnership or corporation creates an investment fund established as a Qualified Opportunity Fund by filing IRS Form 8996 with their federal income tax return. Once designated, 90 percent of the fund’s assets become invested in designated Opportunity Zones to receive preferential tax treatment.
Benefits of Qualified Opportunity Funds
Regarding the US federal tax perspective, investing in QOF provides considerable benefits. Firstly, Opportunity Zone provisions allow investors to reinvest their recently generated capital gains into a QOF within 180 days of the sale or exchange of a capital asset. This allows the investors to defer the US federal capital gain until December 31, 2026.
Additionally, if an investment goes through an investor into a QOF before December 31, 2021, capital gain tax liability reduces by 10 percent and gets recognized on December 21, 2026. Another benefit is that investors holding their interest in a QOF for 10 or more years may become permanently exempt from US federal tax on the QOF investment gains.
Steps To Invest in Qualified Opportunity Funds
Before investing in QOF, clients must follow the rules. Considering all potential implications, filling out the appropriate paperwork, and consulting a tax or financial advisor with QOF knowledge can help streamline the investment process.
Understanding Opportunity Fund Qualifications
Each Qualified Opportunity Fund facilities investments into properties or businesses within Qualified Opportunity Zones. States can nominate low-income communities as Opportunity Zones.
However, the US Treasury Department must certify the nomination. Once a location receives approval, QOFs can begin investing in businesses and properties within the Opportunity Zone for improvement.
Weigh Your OF Against Other Money Goals
It’s vital to ensure all other financial priorities take place. Clients should start by doing the following things:
- Paying all living expenses on time
- Paying down high-interest debt
- Making contributions to retirement accounts
- Funding emergency funds fully
- Planning and saving for significant purchases
Set an Opportunity Fund Target
Once clients get their finances in order, the next step is determining how large the Opportunity Fund should be. Typically, taking an initial investment and cutting it by half is a safe action for investing in an Opportunity Fund. The client can then start by earmarking in small amounts, then by adding to the fund until it’s used or the size they desire.
Decide Where and How To Deposit It
Once clients begin their Opportunity Funds, the next action to take is to decide where to keep them. Ideally, keeping them in a high-interest savings account first can help reach the target amount.
Afterward, moving the Opportunity Funds into a longer-term investment can prevent them from going to waste. In addition, there are many low-cost funds to keep the money until another investment opportunity arises.
Tips for Choosing the Right Option
So how do clients choose the right Opportunity Fund for their QOF? Let’s look at the various tips to make the process less complicated.
Review the Firm’s History
While it’s challenging to search for a fund manager’s history with QOFs, clients can look to a firm’s track record in its area of expertise. Researching qualified real estate development firms make for the best first decision due to QOFs concentrating on real estate. Questions regarding their past choices, the yield for netting investors, and their demonstration of capabilities are necessary to pivot new forms of investment and opportunities.
Understand the Firm’s Track Record
Because thousands of development tracts can qualify under federal regulation Opportunity Zones, virtually any state in the country can offer an Opportunity Zone for investment. However, it is entirely unpredictable whether funds in the zones can become invested. Therefore, only the client and the qualified financial advisor can assess the individual QOF merits.
Proven real estate development presence in particular areas is a measure of possible success. Development firms with constructed properties are more likely to fit all QOF parameters in areas of established operation. Meanwhile, real estate developers don’t have the ability to deliver opportunity zones, despite their knowledge of their local ordinances.
See How They Measure Up
One crucial aspect of choosing a qualified opportunity fund is whether new QOFs have the approval of nonprofit organizations looking to ensure the success of opportunity zones for societal betterment. A review of the National Council of State Housing Agencies (NCSHA) Opportunity Zone Directory provides clients with nonpartisan lists of who’s in the industry.
Consider the funds provided on the nonpartisans lists and conduct due diligence. The site itself doesn’t endorse qualified Opportunity Zones but comprises a digestible, comprehensive list to help clients further understand and narrow down their choices.
We at Sera Capital offer exit planning for clients focused on selling highly appreciated real estate, businesses, and concentrated stock positions. We strive to work with individuals as fiduciaries and not behold to any product sponsor or institution for client solutions. In most cases, the appropriate choice is to choose a 1301 exchange, but not all clients are the same. Our specialty Opportunity Zone investment services are alternatives to 1031 exchanges to better suit our clients’ interests. If you would like to know more about Qualified Opportunity Zone Funds, schedule a free 30-minute phone call with us at Sera Capital today.