Opportunity zones are some of the best investments available for anyone with the funds seeking to lower their tax responsibility. Praised by some as a “more socially conscious form of real estate investing,” opportunity zones offer a way to do good while saving money on your taxes. Here’s what you need to know about IRS designated opportunity zones.
Background: what is an opportunity zone?
An opportunity zone is defined by the IRS as “an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.” These are areas that have been nominated by the state and certified by the US Secretary of the Treasury.
Opportunity zones were created by the 2017 Tax Cuts and Jobs Act. Under this legislation, the zones are meant to increase economic development and job creation in areas that have been traditionally underserved. An area can qualify to be nominated as an opportunity zone if the poverty rate is at least 20% or median family incomes are no greater than 80% of those of their surrounding areas.
Currently, there are over 8700 designated opportunity zones around the country. Once an area receives that classification, it will continue to be an opportunity zone for ten years. To find the nearest opportunity zone to you visit the U.S. Treasury Department's Community Development Financial Institutions Fund.
What do investors need to know about opportunity zones?
The government created opportunity zones to incentivize investment areas in need of rehabilitation, jobs, and a cash injection. There are some great tax benefits to cannabis operators who bring their business to opportunity zones.
The IRS offers investors what they call “Qualified Opportunity Funds.” This option allows an investor to put existing assets with accumulated capital gains into a private fund. The catch is that at least 90% of the fund’s capital must be invested in an opportunity zone. In return, IRS has decreed that QOFs get the following tax benefits:
- Investors can defer tax on prior gains invested in a Qualified Opportunity Fund until the date on which the fund is sold or December 30, 2026 (whichever is earlier)
- If the QOF investment is held for more than five years, there’s a 10% exclusion of the deferred gain
- If the QOF investment is held for more than seven years, the 10% exclusion becomes 15%
- If the QOF investment is held for at least 10 years, the investor pays no capital gains taxes on those investments.
Many investors use an opportunity fund as a savvy way to buy real estate. They’ll purchase a building and lease it out to tenants.
Cannabis and opportunity zones
How can your cannabis business take advantage of opportunity zones? There are two strategies our experts suggest to realizing the benefits of the deferred capital gains tax.
In the first option, imagine your cannabis company just sold stock, your business, or a real estate property. The result is a $1MM capital gain. Upon the sale of those assets, you would technically be taxed on that gain. Instead, reinvest that money in a real estate property located in an opportunity zone. You’ll benefit from the deferred taxation of that gain. If you hold that investment for five, seven, or 10 years, you can partially or completely avoid taxation of that gain – plus any gain on new appreciation in the property that you purchased.
In the second option, imagine you are sitting on a pile of cash – and you’re ready to invest. Look for an investment in an opportunity zone. Any gain due to appreciation of that property can be avoided based on the above rules previously outlined. It’s a win-win for you and your business.
Technically, any property qualifies under the opportunity zone exclusion. The tricky part for cannabis operators is that due to the 280E regulation, cannabis stock gains likely wouldn’t qualify, since tax credits don't apply to 280E. Our recommended course of action is to purchase a real estate property that's housed in a legal entity separate from 280E business (cannabis business) and lease the real estate to 280E.
Reach out to us to help you set up a Qualified Opportunity Fund. We can help you select the right entity and double-check that you are in the right zone.
When tax time comes around, our experts have the background to prepare your tax return with the right election to defer the gain.
We’ll help you realized the right combination of cost segregation and tax deductions to get the most tax savings possible.