Buying a Rental Property in an Opportunity Zone: What You Need to Consider

The Opportunity Zone program can provide certain investment advantages. When conducted properly, buying a rental property in an opportunity zone can generate tax benefits, while assisting with economic revitalization.

But if you’re interested in this particular action, here are five things to ask yourself.

1. Are you in it for the long haul?

You must hold your Opportunity Zone investment for at least 10 years, if not longer, to receive the fair-market value basis step-up. This means any appreciation received can be excluded from your income. But – 10 years is a long time. A lot can happen in a decade. Additionally, an Opportunity Zone investment is highly illiquid. You won’t have access to that money for a long time.

2. Is the Qualified Opportunity Fund you’re considering legitimate?

You don’t invest directly into an Opportunity Zone. Rather, you put your capital gains with a Qualified Opportunity Fund (QOF), which invests that money into a federally designated Qualified Opportunity Zone (QOZ). But that QOF must follow specific requirements:

• It must hold at least 90% of its assets in QOZ property (QOZP).
• It must earn at least 50% of its gross income from business activities within a QOZ.
• It must be organized for the sole purpose of investing in QOZP.
• It must pass the 30-month substantial improvement test.

This requires due diligence when it comes to the QOF’s sponsors. The legitimate ones are transparent and will answer any questions or concerns. However, if there’s a lack of transparency, or some of the answers to your questions seem a little “cagey,” it’s time to move on.

3. Are the property’s fundamentals solid?

Designating a property with the QOZ label doesn’t automatically mean it becomes a great investment. The U.S. Department of the Treasury designated 8,764 Opportunity Zones based on U.S. Census Bureau low-income tracts, not their investment potential.

Because of this, the same due diligence you might perform with any other investment should also be done with a QOZP. This requires an analysis of the QOZP’s physical and financial condition, along with the area in which that asset is located. 

4. Are you able to follow the investment deadlines?

Yes, there’s a deadline when it comes to investing your capital gains into a QOF. Specifically, if you want to defer taxes on that gain, the IRS wants you to invest in a Qualified Opportunity Fund in exchange for equity interest (not debt interest) within 180 days of realizing that gain. This gives you six months from the time you generate a capital gain to find – and invest in – a viable QOF. Failure to adhere to this deadline could mean that you’re responsible for taxes on that capital gain.

5. Are you an accredited investor?

There continues to be discussion about Opportunity Zones and non-accredited investors. But the truth of the matter is that, right now, the program is primarily directed to accredited investors. Accredited investors are high net-worth entities or individuals who are (in theory) better able to handle a huge monetary loss.

As an aside, if you’re a non-accredited investor, you could form your own QOF. But this is a complex task, complete with stringent requirements. There are other potential tax-deferred strategies available to non-accredited investors that don’t carry as much red tape.

The above are just some of the considerations when mulling over buying a rental property in a QOZ. There are other questions and issues to consider as well. To fully understand what’s involved with a QOF investment, check with a qualified financial professional.