Why Invest in an Opportunity Zone?
Many of the key similarities and differences between these two investment options involve IRS regulations, eligible capital gains and deferment guidelines. Your decision on which option to pursue depends on your individual financial goals and requirements.
QOFs offer unique features that distinguish them from DST investments. Organized as corporations, Real Estate Investment Trusts (REITs) or partnerships, QOFs exist solely as a vehicle for Opportunity Zone investments. Individual investors, trusts, partnerships and estates can directly invest in the fund. To meet IRS requirements, a QOF must have 90% of its investments in an Opportunity Zone — if it adheres to the regulations, the fund can make investments on multiple qualified tracts.
Opportunity Zone investments come with inherent potential risk, but they also offer several advantages to consider. The key ways that QOFs can potentially benefit investors include:
- Sizable tax advantage: For those who invest in Opportunity Zones, they will be eligible for a 10% step-up in basis after holding the investment for over 5 years and a 15% step-up in basis after 7 years.
- Benefits communities: This option delivers invaluable resources to economically struggling communities that need it most, contributing to the area’s growth.
- Broad investment criteria: You can defer taxes on capital gains from several assets along with real estate, including business sales, stocks, cryptocurrency, REITs and bonds.
Due to the relatively recent introduction of Opportunity Zones, much of the inherent risk is associated with the uncertainty surrounding regulation. Although there have been several rounds of clarification by the Treasury Department, Opportunity Zone qualification still depends on strict compliance with new, and sometimes ambiguous, regulations.
If a fund does not comply with these requirements, its favorable tax status may not be applicable, thus creating an unintended tax liability for the investor. Additionally, some states do not fully conform to the federal Opportunity Zone tax benefit, so there may be state capital gain tax considerations.
Also, it’s important to recognize that when investing in a QOF which is multi-asset, the sponsor has discretion over the allocation of funds. To better deal with multiple timelines, as funds come in, the sponsor can allocate funding to different projects.
Potential Risks of QOF Investments
Due to the relatively recent introduction of opportunity zones, much of the inherent risk is associated with the uncertainty surrounding regulation. Although there have been several rounds of clarification by the Treasury Department, opportunity zone qualification still depends on strict compliance with new, and sometimes ambiguous, regulations.
If a fund does not comply with these requirements, its favorable tax status may not be applicable, thus creating an unintended tax liability for the investor. Additionally, some states do not fully conform to the federal opportunity zone tax benefit, so there may be state capital gain tax considerations.
Also, it’s important to recognize that when investing in a QOF which is multi-asset, the sponsor has discretion over the allocation of funds. To better deal with multiple timelines, as funds come in, the sponsor can allocate funding to different projects.
Since opportunity zones are typically designated in economically depressed areas, investing in a QOF can be speculative.
Why Invest in Delaware Statutory Trusts?
DSTs offer several advantages for investors to consider, including:
- Capital gains tax deferral: Since DSTs are a like-kind property for a 1031 exchange, you can defer paying capital gains taxes when selling your investment property. Capital gains taxes may be deferred indefinitely if you do not sell the property in the future.
- Potential income opportunities: Investors benefit from the potential for a predictable income from the trust if the DST has acquired high-valued properties in regions with projected growth.
- Ownership in a high-valued asset: Investors can use DSTs as an opportunity to invest in a high-valued property they would not be able to invest in on their own.
- Quick closing: Since the properties are generally already acquired within the trust, investors can purchase their interests right away and close within days following the sale of the relinquished property.
- Depreciation recapture: Depreciation — the difference between your property’s purchase price and adjusted basis — is not taxed with a DST. Depreciation recapture can be deferred indefinitely if you do not sell the property in the future.
- Step-up in basis for heirs: With a DST, the asset basis is stepped up to fair market value at the time of death.
Potential Risks of Delaware Statutory Trusts
Delaware Statutory Trusts have inherent risks common with many real estate investments, including loss of principal and minimal to no returns. Some other possible risks for investors to consider include:
- Lack of liquidity: DSTs are considered a nonliquid investment, and the secondary market is a rare occurrence. The DST sponsor controls the length and exit of the investment and chooses when to sell.
- Lack of control: DSTs are not a hands-on investment vehicle, as real estate professionals manage DST operations. While some investors prefer this setup, investors looking to participate in strategy and operations may want to consider other investment vehicles.
- Lack of cash flow: DST properties are long-term investments, with their performance dependent upon their tenants’ ability to pay rent. Delinquent tenant rent payments, high vacancy rates, rent decreases, higher expenses, and other factors can lead to a lack of cash flow of the DST. Interest rate changes could also affect price appreciation and cash flow potential.
How to Invest in Opportunity Zones and DSTs
Opportunity zones provide investors with special tax benefits, but they also come with risks. Likewise, if you’re making a 1031 exchange and investing in a DST, it’s essential to identify a potential property within 45 days and close within 180 days. The law stipulates that the replacement property must be of “like-kind” market value to the relinquished one. You can also cash invest in a DST if you’re not looking to exchange properties.
It’s important to compare multiple funds to properly evaluate investment opportunities. That’s why 1031 Crowdfunding has created an opportunity zone and DST marketplace where you can compare and evaluate properties and build a customized real estate portfolio.
