Common Misconceptions About Qualified Opportunity Zones (QOZs)

Common Misconceptions About Qualified Opportunity Zones (QOZs)

Posted by on May 22, 2020

myths-word-block-newspaper-IS-1141961887

There are a number of common misconceptions about the Qualified Opportunity Zone (QOZ) Program. To help clarify speculation and misunderstandings, we’ve put together five of the most common misconceptions.

1. The Program Will Transform The Most Disadvantaged Areas

Real estate investors look for a risk/reward balance. Unfortunately, this means that the most disadvantaged areas will likely not receive much investment. The risk is simply too high. Meaning, investors may have to wait a very long time to recoup their investment because of low returns. Investors are more likely to look for areas that are in transition and have better potential than those that are the most disadvantaged.

The Federal Reserve Bank of Philadelphia backs this up with its 2019 OZ case study. It found that areas selected for OZ qualification were mainly in gentrifying neighborhoods. These neighborhoods were experiencing housing price increases before the OZ program and continued to see increases after getting their OZ designation. 

Post-recession growth has been concentrated in only a few wealthy cities, leaving many disadvantaged communities behind. The hope of the OZ program is to make these areas attractive to investors.

2. The Program Will Just Accelerate Gentrification And Barely Provide Any Benefit To Low Income Communities

This is not entirely true. Referencing the Philadelphia Federal Reserve Bank's case study, while most OZ areas were in gentrifying neighborhoods with increasing house prices, being selected as an OZ did not cause house prices to accelerate upward. Instead, they continued on their existing trajectory.

3. Program Legislation Will Get Thrown Out

There is no sound backing for this. Anyone making such claims are doing so purely on speculation. The government has not made any announcements or even hinted at throwing any OZ program legislation out.

4. Non-Capital Gains Cash Is Still Eligible For QOZ Benefits

The QOZ program provides three tax advantages:

  • Temporary deferral of capital gains
  • Reduction of the capital gains tax bill
  • Elimination of the capital gains earned within the QOF

To qualify for the above, only capital gains can be used. Also, those gains must be invested in an OZ fund within 180 days of realizing the gains.

5. Locked Into Current Capital Gains Rate

No one can say what the tax rate will be in 2026. For that reason, some investors balk that their tax deferral rate is getting locked in today when taxes down the road may be much higher. The OZ program has a method for mitigating this risk. It’s called a “step-up in basis.”

A step-up in basis is slightly different from an outright tax rate reduction, but it serves to reduce the amount of capital gains tax the investor will be required to pay. The 10% step-up in basis reduces the amount of capital gains that are subject to the capital gains tax. For example, on a $1 million gain,  the 10% step-up means that after five years, the investor will only owe capital gains tax on $900,000 (of the $1 million gain), based on the current tax rate when the gains are realized.

While investors can be put off with incorrect information about the OZ program, it is certainly worth their time to dig into what is true and what is misinformation. The OZ program can be confusing to some with all of its regulations and fairly complex tax advantages. But that is all part of the due diligence process that real estate investors are expected to do with any deal they are considering investing in.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

 


What is a Qualified Opportunity Zone?

Download The Investor's Guidebook

QOZ Guidebook Cover

What is a Qualified Opportunity Zone?

qoz-ebook-cover-150x176
=