Investments and developments in Qualified Opportunity Zones (QOZs), a product of the Tax Cuts and Jobs Act, are expected to be one of the biggest trends to impact real estate in 2019, including the hotel industry right here in Reno.
Qualified Opportunity Funds (QOF) represent an opportunity for investors in those areas that have been designated as QOZs. More than 8,700 U.S. Census tracts have been designated as QOZs across all 50 states, including Nevada, Washington, D.C., and some U.S. territories.
Given that the QOZs are generally located in low-income or distressed areas, hotel investors may not see the immediate potential of realizing the tax benefits of investing in a QOF.
However, a closer study of the map of QOZs reveals that in many states and key hospitality markets there are QOZs that present strong possibilities for hotel development, such as New York City, Hollywood, the entirety of Puerto Rico and some parts of Nevada.
Many opportunity zones are located immediately adjacent to neighborhoods that have already experienced gentrification and hotel demand is already present.
The Nevada Governor's Office of Economic Development designated 61 opportunity zones throughout the state, including 60 census tracts and one non-low-income contiguous tract in April 2018.
These areas were certified as QOZs by the U.S. Department of the Treasury in June 2018. Some of the Nevada QOZs are located in downtown Reno, downtown Las Vegas, as well as portions of the Las Vegas Resort Corridor. All of these areas may present an opportunity for hotel development or redevelopment.
A real estate investor, hotel developer or other Opportunity Zone investor can realize tax benefits in two ways. First, a taxpayer may defer paying tax on capital gains to the extent that corresponding amounts are reinvested in a QOF within 180 days of when the gain is realized.
Those capital gains are deferred until the earlier of the date the QOF is sold or Dec. 31, 2026. Additionally, if the QOF investment is held for longer than five years at the time, there is a 10 percent exclusion of the deferred gain. If the QOF investment is held for more than seven years, the exclusion of the deferred gain becomes 15 percent.
While the deferral of current capital gains is attractive, it is the second significant tax benefit available to investors in a QOF that seems to be driving the most interest in QOF investment.
If the investor holds the investment in the QOF for at least 10 years, the investor is eligible for an increase in the basis of the QOF investment to its fair market value on the date the QOF investment is sold or exchanged, which results in a permanent exclusion of all post-investment appreciation.
While much of the initial discussion surrounding opportunity zone investment has focused on real estate development, there is also potential to realize the tax benefits if the QOF invests in the operation of a hotel within an opportunity zone.
If a QOF funds the operations of a new hotel that is located in a QOF, even if the underlying real estate is not owned by the QOF, then the QOF may be eligible for the same tax benefits described above.
This means separate QOFs could own the underlying real estate and the hotel operations, with both QOFs potentially reaping the tax benefits from the investment in a new hotel development in an opportunity zone.
While hotel development in a QOZ needs to be a prudent business decision apart from the tax benefits, it can generate an increase in interested investors if investors and owners are willing to satisfy the required tests and holding rules necessary to take advantage of the new tax benefits.
Rebecca L. Miltenberger is a shareholder with Brownstein Hyatt Farber Schreck, LLP. She's based out of the firm's Las Vegas office. Go here to learn more.
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