Expectations are high this year for opportunity zones in the real estate industry. A product of the Tax Cuts and Jobs Act, investments and development in qualified opportunity zones are expected to be one of the biggest trends to affect real estate in 2019. Qualified opportunity funds represent an opportunity for investors in those areas that have been designated as QOZs.
More than 8,700 U.S. Census tracts have been designated as QOZs across all 50 states, Washington, D.C., and some U.S. territories. Given that the QOZs are generally low-income or distressed areas, hotel investors might not see the immediate potential of realizing the tax benefits of investing in a QOF. However, a closer study of the map of QOZs reveals that in many states and key markets there are QOZs that present strong possibilities for hotel development, such as New York City, Hollywood, the entirety of Puerto Rico and some mountain communities of Colorado.
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A real estate investor, hotel developer or other opportunity zone investor can realize tax benefits in two ways. First, a taxpayer may defer paying tax on capital gains to the extent that corresponding amounts are reinvested in a QOF within a specific time frame. Those capital gains are deferred until the earlier of the date the QOF is sold or Dec. 31, 2026. Additionally, if the QOF investment is held for longer than five years at the time, there is a 10 percent exclusion of the deferred gain. If held more than seven years, it becomes 15 percent.
While the deferral of current capital gains is attractive, it is the second significant tax benefit available to investors in a QOF that seems to be driving the most interest in QOF investment. If the investor holds the investment in the QOF for at least 10 years, the investor is eligible for an increase in the basis of the QOF investment to its fair market value on the date the QOF investment is sold or exchanged, which results in a permanent exclusion of all post-investment appreciation.
While developing in a QOZ will not turn a bad hotel deal into a good deal, it can generate a larger pool of interested investors, particularly because the capital gains that can be invested can be generated from any source, not just capital gains resulting from the sale of real estate.
Nicole R. Ament is shareholder and Hospitality, Resort and Recreation Group chair at Brownstein Hyatt Farber Schreck.