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Opportunity Zones 5-Year Basis Benefit Set to Expire

2nd Dec 2021

The expiration of one of OZ’s tax incentives is likely to signal an influx of investment in December.

The start of 2022 will signal changes for Opportunity Zones, as 2021 is the last year to make investments that qualify for the 10% step up in basis and capital gains exclusion. After December 31st, this benefit will no longer be available. So what does this mean for the remaining weeks of this year, and how will things change after January 1st?

Aside from their promising returns and the ability to make a positive social impact, Opportunity Zones have provided investors with three key benefits:

  1. Exemption from tax on gains realized upon the exit of an OZ investment held for at least 10 years
  2. Deferral of tax on capital gains that are invested into a Qualified Opportunity Fund by December 31st, 2026
  3. Permanent exemption from tax on 10% of capital gains invested into a QOF by December 31st, 2021, and held for at least 5 years

This last benefit is the one that will be expiring at the end of the year. While Opportunity Zones will still be an enticing investment, especially given the possibility of the first two key tax benefits, it’s undeniable that investors have a lot to gain by making their investments before the deadline.

Because of this, we expect Opportunity Zone funds to benefit from a significant increase in investment dollars in Q4. Managers will be racing to make their funds available during this time, and investors will be moving quickly to get their investments in before the end of the year.

The big question is: what will happen after the first of the year? There are four possible scenarios:

  1. Investment will normalize after the first of the year, returning to previous levels but remaining robust.
  2. Investment will continue at record levels, with funds that attempted to begin open enrollment in Q4 but missed the deadline continuing to fundraise at record pace.
  3. Investment will dip during Q1 because many investments that might normally happen during that period were shifted to Q4, and as a result, Q1 will be light but numbers will return to previous levels in Q2.
  4. Investment will decrease permanently as investors will shy away from Opportunity Zones once the 10% exclusion for capital gains is no longer an option.

Though there are certainly those who predict the downfall of Opportunity Zones, we don’t share in this pessimism, and expect choice #1 to be the most likely. These investments have proven to be extremely popular and have generated billions of dollars in investment for long-neglected areas, and we expect this to continue. It’s possible that there may be short-term increases or decreases, but the success of the initiative will continue on pace.

However, don’t rule out option #2. It’s long been understood that the Biden Administration is going to raise capital gains tax rates. The higher the rate, the more investors will be looking to defer taxes, making the Opportunity Zones tax deferral benefit even more attractive than it already is. This could lead to increased investment in OZ as its benefits become more valuable.

Opportunity Zones are proving to be one of the most popular impact investments ever. Our research at JTC continues to show that investors have different motivations when it comes to investing in Opportunity Zones than they do with traditional financial products. It’s not just the tax incentives that bring investors to OZ, but the ability to create a lasting impact.

The reality is that the elimination of the 10% step up in basis is likely to have only a small impact on the overall financial return of a 10 year investment. Therefore, while we might see slowing in January, we expect 2022 to be an even bigger year for OZ than 2021.

JTC has been a leader in Opportunity Zones fund administration, with real-time impact monitoring and a full suite of compliance and reporting solutions. JTC has also developed a set of best practices for OZ fund administration that is paving the way for better reporting across the industry. Opportunity Zones have been a huge success, and we expect that by showing investors that these projects are creating real impact in underserved communities, investment will continue to grow.

Download our Opportunity Zones Fund Administration Factsheet!

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