America was founded on tax avoidance.
As patriots, It’s only right that we honor that tradition. Sure, everyone should pay what they’re legally required to. But not a dime more.
As real estate investors, we’re afforded multiple strategies to avoid taxes. Write offs, 1031’s exchanges, solo 401k’s, etc. We can shield a lot of money from taxation.
However, developers, builders, and flippers often generate capital gains that can be difficult to shield from taxes.. Flips, for example, are usually taxed at the short term capital gains rate. This will probably be equal to your ordinary income tax rate. If you make enough money, your ordinary income rate could be north of 40%.
This is where relationships with outstanding CPA’s come in. My brother, Jake Drum, is a CPA at Tidwell Group. He casually mentioned opportunity zones at a family dinner. They sounded too good to be true. Naturally, I spent the next 48 hours researching them relentlessly.
After gaining some understanding, I asked fellow investor and CPA, Phillip Arthurs, about opportunity zones. He researched them, and confirmed what I thought. They are a huge opportunity. Especially in Birmingham.
From Phillip’s Blog:
Investors are cheering over the new tax legislation that came out recently stemming from The Tax Cuts and Jobs Act. The Act created Opportunity Zones to spur investment in distressed communities throughout the country. New investments in Opportunity Zones can receive preferential tax treatment. Every state in the U.S. has been mandated to select at least one opportunity zone for each of its counties.
As a result of this legislation, an investor can now take gains generated from outside of a zone and invest it in a business inside of a zone (or Qualified Opportunity Zone Fund) to defer the gains for up to 10 years as well as reduce it down to a 15% rate. Furthermore, appreciation in the investment can grow tax free for up to 10 years.
This sounds great, right? Well, there are a lot of other requirements and rules that can get in the way. For instance, you have to spend at least what you have in the property/business on improvements. Also, if you don’t hold the investment for the full 10 years, you won’t be able to eliminate all of the gain on the appreciation.
Another factor for us real estate investors to consider will be the type of investing we’re doing. If you are a wholesaler or fix-and-flipper, you might have trouble taking advantage of this. One way that I’ve thought of for wholesalers and flippers to make this work would be through the use of Qualified Opportunity Zone Funds. If you were to create a fund and keep the money reinvested in Opportunity Zones each time you wholesale or flip a property, you might have a good case for using this tax savings vehicle. This strategy is untested and only an idea that I intend to research further.
According to the U.S Treasury’s website, the Treasury and the IRS plan to issue additional information on Opportunity Zones and Qualified Opportunity Funds. The additional guidance will address the certification of Opportunity Funds, which are required to have at least 90 percent of fund assets invested in Opportunity Zones.
For Example
The example often used is an investor with a 1 million dollar capital gain. Let’s say they would’ve been taxed 400k this year. If they reinvest the 1 million in QOZF (qualified opportunity zone fund), then the 400k will be deferred and reduced over time. Potentially turning into only 150k ten years from now. If you make 10% annual returns over those 10 years the difference is huge! It’s an extra $637,496.
Now here’s the crazy part. The gains on that 1 million you invested could be tax free. Not deferred. Tax free! This is great American legislation people.
That 10% annual return would never be taxed. If everything is done right, this investor would end the ten years with $2,593,742. His tax liability would be only about 150k.
This example could be conservative for us. The opportunity zones in Birmingham have cap rates even higher than 10%.
Where are the Opportunity Zones in Birmingham, AL?
Opportunity zones are designated by census tract. Here are the census tracts designated in Birmingham.
01073000100 – East Lake/Roebuck
01073000300 – Woodlawn
01073000400 – Airport/Inglenook
01073000500 – North of The Airport
01073000700 – Village Creek/Douglasville
01073000800 – North Birmingham
01073001200 – Finley Blvd/Thomas/Village Creek Junction
01073001400 – East Thomas/Enon Ridge
01073001500 – North Birmingham/Druid Hills
01073001600 – Norwood
01073001902 – Wahouma
01073002200 – Eastlake/Brown Springs (West of 77th ST)
01073002303 – Eastlake/Oak Ridge/Gate City
01073002400 – Sloss/Parts of Avondale
01073002700 – Core Downtown
01073002900 – West of Downtown/Smithfield
01073003001 – Bush Hills
01073003002 – Graymont/College Hills
01073003200 – Ensley/Tuxedo Junction
01073003900 – Rising – West Princeton
01073004200 – North Titusville
01073004500 – Southside/Five Points South
01073010200 – Bessemer
01073011209 – Centerpoint/Jeffserson State CC
01073011705 – Gardendale/Fultondale
If you’re thinking about using this strategy, It’s important to make sure potential buys are actually in one of these census tracts.
How do I utilize this strategy?
The IRS is still providing guidance on the specifics of this new opportunity. They recently clarified what they mean by a certified “qualified opportunity zone fund.” (QOZF)
It’s intended to be a self certification on your taxes. So it’s not that hard to start or become a QOZF.
If you’re lucky enough to have large capital gains liabilities, here are a couple way’s you could take advantage of this strategy.
- Invest institutionally – Large investors have already begun raising traditional funds to utilize this strategy. The Fundrise Opportunity Fund intends to raise 500 million by the end of this year.
- Partner – Other investors might be interested in operating this strategy with you. It may even be possible to raise money from outside investors.
- DIY – Just start investing in the zones yourself. You may need a separate entity to be designated as a QOZF.
For all of these strategies, I’d recommend consulting a CPA. There are a number of rules you’ll need to follow. I’m not a CPA , and don’t give tax or legal advice.
Thanks for reading! I love to hear feedback. Send me a text, or email rob@robdrum.us