For an audio version of this post, please click on the speaker icon (top left).
Please check out part I of this interview to get you up to speed.
As we were concluding the interview, we delved into another fund that Origin is proud to be offering and one that has the potential to save investors a lot of tax liability if used correctly.
I felt the information about this particular fund was worthy of its own post and therefore chose to break the interview into two parts, the second of which you are reading now.
Another Origin Fund that is just opening is the QOZ fund (Qualified Opportunity Zone), a fund that allows investors to take advantage of significant federal tax benefits for opportunity zone investing.
Can you share with my readers some of the benefits of this fund?
Does opportunity zone investing carry with it a higher level of risk than a more traditional fund?
The benefits of investing in opportunity zones are outstanding.
Potentially you have the tax benefits of municipal bonds with the return benefits of equities.
You are probably going to get a return on an after tax basis of 60-100% more than a traditional taxable investment.
If your expected return of traditional real estate is, for example, 10-12% over the next 10 years, an opportunity zone investment will generate close to 15% on an after tax basis whereas a traditional investment will net close to 7% on an after-tax basis.
The first benefit is the tax deferral.
As an example, let us say you experience a capital gain this year of $1M from any source.
The way the QOZ law works is that if you invest that capital gain into a QOZ fund, the first benefit you get is deferring those taxes to 2026, payable in 2027.
For that $1M capital gains you will have 20% capital gains tax plus the NIIT which is another 3.8%, totaling $238k which will now be due in 2027 instead of next year.
The second thing is that as long as you invest in 2019 you get a reduction in your tax bill by 15% and that new balance again is due only in 2027 (in this example instead of $238k, you will now owe $202k)
In addition, the money you invest in the fund will grow tax free so long as you keep it in a QOZ investment for at least 10 years.
Therefore, if your $1M grows to $3M in 10 years and you take it out in year 11 you owe no taxes on any of the $2M gains.
The reason why the law was created was because they wanted to unlock the trillions of dollars of capital gains sitting out there by wealthy people and have it go into what they called distressed economic neighborhoods.
There are 8700 qualified opportunity zones throughout the United States.
A QOZ fund has to invest your capital in essentially ground up deals in these neighborhoods.
I know economically distressed sounds scary but when you really go out into the field and you look at some of these locales, these are really just areas in transition.
As a real estate investor, you want to be here because this is where the growth and transition is happening and where the center of activity is moving to.
I can’t say that about all the areas, but about 5-10% of QOZ are in these up and coming neighborhoods.
The reality is that most of the QOZ deals that are getting done today are market rate deals that capital was chasing well before the QOZ law came into existence.
Every investment manager and property investor is looking for deals in strong areas that are growing.
One such area is Charlotte, which has a light rail implemented that created an enormous catalyst for every neighborhood along its service and those areas happen to be classified as QOZ.
In Chicago there are areas along the lake front that are also QOZ qualified areas.
In Tempe Arizona there are QOZ areas that already have class A developments.
You kind of scratch your head sometimes on why these areas are considered to be in economically distressed regions.
It creates a lot of opportunity but you really have to use a manager who understands the local nuances of the market because no one will make money in a truly economically distressed community.
What are some of the rules an investor has to follow in order to take advantage of these tax benefits in a QOZ fund?
You have 6 months from the time you realize the gains until you invest it.
As long as you invest in a QOZ fund and that fund takes your money (not just a commitment) then you qualify.
You only have to invest the gain and can do something else with that principal.
This is different from a 1031 exchange in which you have to invest the principal and the gains.
The only disadvantage of a QOZ investment versus a 1031 exchange is that the tax liability eventually has to be repaid with a QOZ.
A QOZ is especially favorable for those who have short term capital gains (which there are higher tax implications as it is treated as ordinary income).
You mentioned your fee structure for the Income Plus Fund in Part I of our interview.
How does the fees for the QOZ fund differ?
The QOZ fund is nearly identical to the Income Plus Fund in that there is a zero committed capital fee.
Again there is an asset acquisition fee system implemented.
The performance fee is higher at 15% because of the complexity as those deals are ground up developments.
These deals therefore take a lot more time and staff.
The expected and net return is also much higher in these deals for the investor despite the higher fees.
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