Even though rising inflation and interest rates are increasing the costs of doing business in the real estate market, the best days of QOZ are still underway. So what is the relationship between opportunity areas and inflation? What if it was even positive?
In June 2022, inflation reached a four-decade high of 9.1%. Although it has come down somewhat (to “just” 7.1% in November), there is no sign that inflationary pressures will disappear as the main concern for most investors in the near future.
Of course, rising prices aren’t the only concern we’re facing right now. The inflationary spiral of 2022 led directly to a series of increases interest ratewhich in turn partially directly resulted in a double-digit loss in the stock market.
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Is help on the way for the US economy? So as not to hear the lion’s share of economists talk about it. Those who do not believe that we are in a recession right now, see one in the next six to twelve months, and the only disagreement seems to be its duration and severity.
Is there a positive relationship between opportunity zones and inflation?
Given this context, what investors need to know now about opportunity zones (opens in a new tab) and macroeconomic turbulence? Is it even possible that there is a positive relationship between inflation and opportunity zones? Insofar as real estate investment is recognized as one of the best historical hedges against inflation, then the answer is certainly yes!
Created by the Tax Cuts and Jobs Act of 2017, opportunity areas (opens in a new tab)also known as Qualified Opportunity Zones or QOZs, run the gamut from rural areas with little economic development and few services for their residents, to heavily populated cities with transitioning neighborhoods and industrial zones.
Opportunity Zones have multiple tax benefits
Of course, while many investors are at least partly motivated by the possibility of seeing their investments pay off in the form of community development, the positive return from such investments, along with multiple tax advantages, remains a primary motivation. Tax deferral to 2026, generally considered payable in 2027, is helpful to many CPAs and investors for tax planning, and the value appreciated in an opportunity fund is 100% tax-free if held to term and if all IRS rules are followed.
To be more clear…
Any corporation or individual with unrealized capital gains may qualify to make a opportunity zone fund (opens in a new tab) investment and benefit not only from the potential return on their investments, but from at least one of the two main tax advantages:
- Temporary deferral of capital gains taxes. Investing the gains made in a qualified opportunity fund means that those capital gains are not taxed until the end of 2026 or until the asset is sold, whichever comes first.
- Permanent exclusion from taxable income on any new capital gains. Finally, if an investment is held for at least 10 years, capital gains taxes on the Opportunity Zone investment are waived entirely.
Investors with a real estate bent often see added appeal if their dollars are invested locally, and this is where OZ funds really have the potential to shine. The 8,762 census tracts that are designated opportunity zones (opens in a new tab) represent 50 states, four U.S. territories, and the District of Columbia, so it’s relatively easy to find an OZ fund with local interest and significant investment potential, no matter where you are.
How does inflation and general macroeconomic turmoil affect the feasibility of QOZ investments?
It’s important to remember that while real estate in general is universally held in high regard as a hedge against inflation, the idea of investing in development-stage real estate is a bit more nuanced. As with any investment, risk and reward are intertwined and should be considered accordingly.
QOZ funds find themselves facing headwinds as inflation and interest rates continue to rise, and with the Fed promising as many interest rate hikes as needed to rein in rising inflation, it doesn’t seem like there is no end in sight to the spiraling costs of doing business in the real estate market.
So are the best days over for Opportunity Zone funds? In a word: NO
In fact, Congress is now considering extending the OZ benefit for at least two more years. Although the returns from QOZ investments may be difficult to project in the short term, they are not intended to be short-term investments and should not be considered as such. For investors sitting on large capital gains, the OZ program should be viewed as it was intended: as an extraordinary tax incentive program that allows investors to defer large capital gains of any investment that has significantly increased in value.
It doesn’t matter if your gains come from a turbulent stock market, the sale of a closed business, or a real estate deal that took advantage of years of historically low interest rates. The tax benefits associated with OZ funds provide an umbrella against a potentially huge tax burden.
It is not difficult to visualize higher interest rates in the foreseeable future, which will increase the monetary value of capital gains. Coupled with likely higher federal and state tax rates, the value of investing in an OZ fund cannot be underestimated as a way to reduce current tax exposure, with the long-term potential to eliminate it. completely.
As always, it is wise to consult your tax advisor and financial planning team closely before making any investment.
Daniel C. Goodwin, pension advisors (opens in a new tab) and AAG Capital, Inc. (opens in a new tab) are not lawyers and do not provide legal advice. Nothing in this infographic should be construed as legal or tax advice. An investor would always be advised to seek competent legal and tax advice for their own circumstances and state specific laws. Visit our website at provident1031.com (opens in a new tab).