It’s not often that niche tax topics are used to score political points. But in last month’s US presidential debate, Donald Trump did exactly this when he bragged about launching opportunity zones.
Opportunity zones (OZs) were first implemented as a small but significant part of Trump’s 2017 Tax Cuts and Jobs Act.
The idea behind OZs is simple. The Government identifies regions of the country that desperately need investment (in housing & infrastructure), and offers tax breaks for investors to provide it.
When OZs first launched, they flew under the public’s radar. But the financial industry immediately recognized their significance.
In July 2018, the IRS finalized the list of areas that qualified as opportunity zones, and the first OZ investment funds arrived just a few weeks later.
Opportunity zones aren’t without controversy, with many critics saying that the program has failed to meaningfully help the low-income areas it was meant to uplift. But for investors, there’s no denying that OZs are a potential tax goldmine.
The tax benefits have diminished since launch, but it’s still possible to use them to delay or entirely eliminate substantial capital gains taxes.
In this article, we’ll explore:
- The tax benefits of investing in OZs
- What kind of investments OZ funds make
- Some of the investment options currently available
- And why current OZ tax benefits won’t last forever
But first, we’ll explore the origin of OZs – and the surprising person who came up with them.
Let’s go 👇
Table of Contents
How to Invest in Opportunity Zones
Irexa specializes in alternative investment strategies rooted in tax mitigation.
They take a personal approach, working with your tax professional to minimize your tax liabilities, maximize after-tax returns, and help you keep more of what you earn.
They offer serious investors access to Opportunity Zone projects, 1031 Exchange services, and Tax Mitigation strategies.
Opportunity Zones
- Big tax incentives: Investors can defer capital gains taxes and potentially eliminate them altogether after holding for 10 years
- Potential for substantial appreciation in property values.
- Positive community impact: Invest in projects that drive economic development, create jobs, and improve infrastructure in underserved communities. Learn more.
1031 Exchanges
- You may recall last year’s issue on 1031 Exchanges, which defers capital gains taxes by swapping one investment property for another
- The world’s best investors use these to create generational wealth. But you need to work with an expert to set it all up. Irexa can help.
Other Tax Mitigation Alternatives
- 721 UPREIT Exchange Properties
- Conservation Easements
- Energy Programs
- Tax-free Retirement Programs
- Non-traded REITs
- Private Equity Funds
- Secured Corporate Debt
Explore alternative, high-expertise, and high-potential investment opportunities with Irexa. Click below to connect with the founder, Robert.
A brief history of Opportunity Zones
OZs are actually the brainchild of Sean Parker, the multi-billionaire tech mogul of Napster & Facebook fame.
According to Parker, the idea for OZs as a solution to America’s regional economic inequality came to him in 2007 while traveling through the foothills of Tanzania.
In the wake of the trip, he spent a chunk of money to found and fund the Economic Innovation Group, a bipartisan think tank designed to promote the idea of OZs politically.
If you ask Parker, he’d probably say that trying to fix economic inequality through OZs is part of his broader philanthropic efforts, which include autoimmune prevention and cancer research.
If you ask critics, the narrative of OZs as philanthropy is just another way to justify more tax breaks for the rich.
Regardless of the motivation, in 2015 the EIG published the original whitepaper outlining and proposing the basic ideas behind opportunity zones.
The paper reviewed previous attempts to promote investment in underserved regions, including Enterprise Zones and the New Markets Tax Credit program — but noted that they failed to live up to expectations, often due to a lack of serious incentives.
In comparison, OZs were designed to provide meaningful value to investors through capital gains tax breaks.
Opportunity zones help reduce capital gains taxes
Suppose you’re a Silicon Valley angel investor who has earned $100 million in capital gains by betting early on a hot tech company that IPOs.
If you go to cash out your shares, you’ll likely be stuck with a tax bill of $23.8 million.
The bulk of that tax bill comes from a top long-term capital gains tax rate of 20%.
But an extra 3.8% gets sucked out through the net investment income tax on capital gains for high earners, upping your total tax burden to 23.8%.
As a result, you might be inclined to just hold your shares and let the investment ride. Sure, this comes with some risk — the stock could tank after IPO, or stay flat for years. But who wants to pay a ~$24 million tax bill?
While this mindset makes perfect sense on a personal level, it’s not optimal on a social level.
Here’s why: if you keep your money locked up in an existing investment, there’s less capital available to finance new ventures that can power economic growth and create jobs.
And as we all know, many areas in the US desperately need an injection of fresh capital.
Regional differences in America’s economic prospects have only grown wider since Sean Parker’s trip to Tanzania. While wealthy areas have gotten significantly wealthier, poor areas have experienced far less growth.
OZs attempt to solve this issue by allowing investors to defer or eliminate taxes on existing capital gains if they invest those gains in economically impoverished areas.
How Opportunity Zones work
The basic process goes like this:
- Sell an existing appreciated position.
- Take the capital gains associated with that position, and
- Invest them in a Qualified Opportunity Fund, which holds at least 90% of its capital in eligible assets within a Qualified Opportunity Zone.
Today, 8,764 census tracts are classified as Qualified Opportunity Zones. These are specific geographic areas the government has recognized as needing investment, and therefore are eligible for tax incentives.
Note that the tax advantages we’re about to discuss are associated with federal taxation.
States have their own idiosyncratic policies. Some support OZs with additional incentives, while others refuse to conform to federal rules and make things more complicated come tax season.
There are three distinct federal tax benefits associated with OZs.
One has already expired, but two are still active – including the largest of the three tax breaks.
Benefit 1: Defer gains until 2026 (Active)
The first OZ tax benefit is the ability to defer recognizing eligible gains until December 31, 2026 (or until you cash out your OZ investment, whichever comes first).
Now, deferring taxes obviously isn’t as attractive as eliminating them. But remember that deferring taxes is basically an interest-free loan from the government that grants you more time to accumulate gains on your capital.
Take our earlier example of the angel investor with $100 million in eligible capital gains and a $23.8 million tax bill.
By deferring taxes for about two years, the investor keeps an extra $23.8 million in their portfolio over that period. Assuming standard investment returns of around 7-8%, these additional funds would earn ~$3 million that they wouldn’t have earned otherwise.
This benefit of OZs is similar to 1031 exchanges — a tax deferral strategy used in real estate.
1031 exchanges theoretically allow you to defer taxes indefinitely. In contrast, OZs have a fixed timeline (although there is some legislative interest in extending the timeline).
This benefit was most attractive back in 2018 when OZs first launched, since it allowed investors to accumulate gains for eight years, not two.
But hey, there’s still time to squeeze extra cash out of deferred taxes!
Benefit 2: Step-up in basis of 10% or 15% (Expired)
Originally, OZs offered a unique step-up in basis on the original eligible gains of 10% or 15%.
However, this tax benefit was time-bound, requiring investors to hold their OZ positions for at least five or seven years before 2026.
Since that’s no longer possible, this tax benefit has expired.
Benefit 3: Get market value basis if you hold for 10 years (Active)
This is the biggest tax break associated with OZs, and thankfully, you still have a few years left to take advantage of this.
Suppose you invest eligible gains in a Qualified Opportunity Fund and hold the position for at least 10 years. In that case, you increase the basis of your position to the fair market value when you go to sell it.
Since capital gains tax is owed on the difference between the sale price and basis, you’ll owe no capital gains tax on the transaction!
This can be extraordinarily lucrative, as it allows you to compound your initial OZ investment for over a decade and owe no tax on the backend.
However, there is a slight catch that isn’t obvious at first glance…
Even if you make an OZ investment today and plan to hold the position for 10 years, you can only defer the initial gains with which you made the investment until 2026.
Sometime around April 2027, you’ll have to pay capital gains taxes on those eligible gains, even though you haven’t sold the position (this is known as phantom income).
Interestingly, some OZ funds are paying a special distribution in 2026 to help investors manage this phantom income tax bill.
Note that the final round of capital gains eligible for OZ investing are those recognizable in 2026. Gains stemming from asset sales in 2027 or beyond are ineligible.
While you still have a few years to invest into an OZ fund eligible for the 10-year tax exclusion benefit, the clock is ticking…
Talk to our friend Robert at Irexa — he’ll walk you through your options.
Understanding OZ’s special rules
Compared with other tax incentive programs, OZs are designed to be relatively straightforward.
But there are still a few special rules that you need to be aware of if you want to invest in this space.
1) Only capital gains are eligible for tax benefits
Spotting the 10-year tax exclusion benefit of investing in OZs, you might want to invest more in Qualified Opportunity Funds than you have eligible gains available.
While there doesn’t seem to be a rule against investing non-gains cash into OZs, you’ll still owe all the usual taxes on that amount when you sell your position — meaning no 10-year exclusion for you.
2) You have 180 days to make an OZ investment
Once you sell your original asset, you have 180 days to reinvest those capital gains into an OZ fund to be eligible for tax benefits.
In fact, this rule is where the final shot clock on the 10-year benefit comes from.
If you sell your original investments and recognize a capital gain on the final OZ eligible day (Dec. 31, 2026) you have until June 28, 2027 to reinvest those proceeds to avoid capital gains tax on their appreciation.
3) Not all assets are eligible for OZ funds
Qualified Opportunity Funds must hold at least 90% of their capital in eligible assets in order for investors to qualify for tax benefits.
Eligible assets are known as Qualified Opportunity Zone Property. This is a fairly permissive category that includes shares of companies (both startups and mature businesses) and real estate (both residential and commercial) located within the OZ.
OZ real estate projects, however, need to construct new property or ”substantially improve” existing property. You can’t just buy and hold real estate.
Finally, OZ funds cannot invest in prohibited businesses, including golf courses, liquor stores, and other vice industries.
Are Opportunity Zones worth it?
So far, we’ve looked at the ins and outs of how opportunity zones work.
Now, let’s consider whether these investments are actually worth it for investors.
The benefits are highly dependent
On the surface, the tax advantages provided by OZs look too good to ignore.
But if you run the numbers, you’ll find that the situation is more nuanced.
Assuming that an investor has an asset that they could sell today to generate > $100k worth of gains, we put together a spreadsheet comparing three different strategies:
1) Non-Opportunity Zone SOLD
The investor sells the original asset and reinvests the money in a taxable asset. This is a double-taxed strategy (the initial sale of the original asset and the final sale of the reinvested asset).
2) Non-Opportunity Zone HOLD
The investor holds their original asset and only sells it at the end. This is a single-taxed strategy (the final sale).
3) Opportunity Zone
The investor sells the original investment and reinvests the money in an OZ fund. This is also a single-taxed strategy (the 2026 recognition of gain).
Under the assumptions listed, the results show that while OZ is much better than Non-OZ Sold, it’s only slightly better than Non-OZ Hold.
For example, if both OZ and non-OZ strategies have pre-tax annual rates of return of 20%, the difference in final value between Hold and OZ increases to 5.3%.
We created a spreadsheet you can play around with to see if Opportunity Zones make sense for your financial situation. You’ll need the All-Access Pass to download it.
You may stumble on a surprising result: OZ tax benefits become more valuable at higher rates of return, even if the rate of return between OZ and non-OZ investing remains the same.
To maximize the tax benefits of OZs, it probably makes sense for them to be a part of the risk bucket in your portfolio.
So it’s good that so many OZ funds do ground-up development projects, a relatively risky form of real estate.
Details like this capture how small adjustments to certain factors can make OZs more or less enticing:
Tax rates
Investing in OZs might not make much of a difference if you’re subject to a 15% capital gains tax rate like most people.
But if you have a 23.8% long-term rate (like very high earners) or are paying short-term capital gains (which are taxed as ordinary income) then OZs are more attractive.
Size of the gains
A 3% difference on $200k results in a final balance that differs by “just” $6,000 – which might not necessarily be worth optimizing your tax strategy for.
But if we’re talking about gains of $2 million, then the difference becomes a much more substantial $60,000.
OZ returns vs other investments
Target returns for OZ funds vary, but a range of 10-20% is common.
Whether or not an OZ investment makes sense will depend on the other investments you could make with your money.
If you can sell your original investment today and invest your cash in a taxable investment that you think will generate 25% returns, the tax benefits of OZs might not be able to outpace the return differential.
How to invest in Opportunity Zones
In the right circumstances, opportunity zones can provide some astounding tax savings.
But not in every circumstance. You’ll have to run the numbers based on your tax rate, gain amount, and investment options available to see if it’s the right play for you.
If you’re still bullish on an appreciated investment, it might not be worth it to cash out just to take advantage of OZ tax benefits – but if you want to sell anyway, then OZ funds are definitely worth considering.
If you want to explore opportunity zone investing, today’s sponsor Irexa specializes in them – along with a slew of other tax mitigation strategies.
Last week, I had the chance to speak with Irexa founder and Alts community member Robert Boggess to learn more about how these funds work.
Robert’s knowledge in this space is unparalleled, and we spoke at length about some of the specific OZ funds he finds most compelling — including some in sectors outside real estate (like oil & gas).
If you’d like to chat with Robert, you can express interest here.
Aside from Irexa, here are some other options to explore:
- Belpointe is a (thinly traded) public Qualified Opportunity Fund (OZ: NYSE)
- OpportunityDB has an online database of Qualified Opportunity Funds
- In the past, Fundrise has raised an opportunity fund. It’s closed now, but it’s worth watching for any future activity.
That’s all for today.
Reply to this email with comments. We read everything.
See you next time, Brian
Disclosures
- This issue was sponsored by Irexa
- Neither the author, nor the ALTS 1 Fund, nor Altea have any holdings in any entities mentioned in this issue.
- This issue contains no affiliate links
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