Investing in Farmland Within Qualified Opportunity Zones

The following commentary is summary in nature and not intended to provide tax advice or advice of any kind. Qualified Opportunity Zones and the potential tax benefits are complex and require intimate knowledge of an individual taxpayer's overall tax and investment strategy.

The Qualified Opportunity Zone program is an initiative aimed at drawing investment capital into underinvested areas of the United States. The program provides the potential for qualified investors to take advantage of certain tax benefits on investments of eligible gains made within these designated zones.

These designated areas can include farmland properties. If meaningful improvements are made to increase the productivity and value of the farmland, investing through a Qualified Opportunity Zone Fund that meets certain criteria may be qualified to take advantage of the associated tax benefits.

This article explores what Opportunity Zones are, how they work, and how certain investors may be able to participate in the tax incentives offered by investing into Qualified Opportunity Zone Funds.

Key Takeaways:

• Opportunity Zones were established to provide a tax incentive for private long-term investment in economically disadvantaged areas
• Potential tax benefits include ability to defer tax on eligible capital gains until December 31, 2026 and the possibility of tax-free growth for QOZ investments held for 10 or more years
• Qualified properties are invested via Qualified Opportunity Funds which, among other requirements, must have 90% of their qualifying assets located in an Opportunity Zone

What This Means for You

Investing in qualified opportunity zone funds can be speculative and involve significant risks. As a result, these investments may not be suitable for all investors. There is no guarantee that an investment in a QOF will yield a profit. Note that depending on any changes to tax legislation, capital gains rates at the time of sale or the end of the deferral period on December 31, 2026 could be at a higher rate than in 2023. Additionally, most Qualified Opportunity Zone Funds do not seek a determination letter from the IRS so there can be no certainty that status will be recognized. Due to the level of complexity involved, investors should consult with their legal and tax advisors when considering Qualified Opportunity Zone investments.

What Is an Opportunity Zone?

The Qualified Opportunity Zone program was created by the Tax Cuts and Jobs Act, in December 2017 to spur investment into economically distressed parts of the country by providing tax benefits to qualified investors who invest eligible capital into these communities, known as Qualified Opportunity Zones (QOZs). Individual states nominated areas and those that met the IRS criteria were certified by the U.S. Department of Treasury in 2018. Designation as an Opportunity Zone remains in place for at least 10 years.

At present, new Opportunity Zones can’t be created or changed. According to the U.S. Department of the Treasury, if the boundaries of an individual census tract are redefined in future census releases, Opportunity Zone designations will not be altered.

Within this specific zoning designation, new investments of recognized eligible capital gains within the designated time period may under certain conditions realize preferential federal tax treatment.

Where Are Qualified Opportunity Zones Located?

There are over 8,700 Opportunity Zones nationwide, covering 12% of U.S. census tracts, and there is at least one zone in every state. Rural areas make up 23% of Qualified Opportunity Zones.

Source: United States Department of Housing and Urban Development.

What Is a Qualified Opportunity Zone Fund?

A Qualified Opportunity Fund (QOF) is an investment vehicle that is organized for the purpose of investing in a Qualified Opportunity Zone and holds at least 90% of its assets in QOZ property. A QOF can invest directly by holding business property in a QOZ or indirectly by holding stock or an ownership interest in certain Qualified Opportunity Zone Businesses located in a QOZ. As the intent of the program is to deploy investment capital in particular areas, it is expected that each QOF will continue to invest in improvements to the property.

A QOF must abide by the following criteria:

• Be organized for the purpose of investing in a QOZ
• Files either a partnership or corporate federal income tax return
• Hold at least 90% of its qualified assets in a designated QOZ

Who Administers a Qualified Opportunity Fund?

Any entity that files taxes as a partnership or corporation can establish a QOF.

In the case of AcreTrader investment offerings and many other real estate investment opportunities, this role will be filled by an offering sponsor. This individual or company is the entity that will ensure the fund meets the above requirements and that must operate and oversee the inner workings of the fund. Frequently, the sponsor is compensated for such services via annual management fees.

Potential Tax Benefits of Investing in Opportunity Zones

Subject to each individual’s tax strategy as developed by his or her tax advisors, there are two potential tax advantages available to investors making a qualified investment in a Qualified Opportunity Zone via a Qualified Opportunity Fund:

1. Temporary deferral of taxes on reinvested capital gains: An investor who has recently completed a capital gains transaction can reinvest their eligible capital gains into a Qualified Opportunity Fund generally up to 180 days after closing, and taxes on those eligible gains can be deferred until the end of 2026.

2. Potential for permanent reduction of capital gains taxation on QOZ investments held for 10 years or more: If an investment in a QOF is held for more than 10 years, any appreciated capital gains accrued after the initial qualifying investment in the Qualified Opportunity Fund are expected to be tax-free, provided no disqualifying event has occurred in the interim. This is what’s sometimes called the Opportunity Zone 10-Year Rule.

While the QOZ program offers a potential tax advantage to investors, it is important to note that investors may only experience preferential tax treatment by investing eligible gains; non-eligible ordinary and capital income investments are not eligible for the tax treatments described above.

How Does a Qualified Opportunity Fund Work?

To put it very simply, investors fund a special purpose fund, which then invests in and develops or improves property in identified QOZ areas and which then manages ongoing operations.

This chart depicts one example of the flow of capital from an investor to a QOZ property.

Considerations When Investing in a Qualified Opportunity Zone

The QOZ program doesn’t come without risks and important considerations. Make sure to speak with a tax advisor before investing in a QOF. As with any investment product, its stipulations require extra due diligence for any interested investor to ensure their participation will qualify. Furthermore, in order to potentially maximize the tax benefits, investors should plan on holding their investment for longer durations, at least 10 years.

Below are additional considerations to take into account when exploring QOZ investing:

• Consider the expertise and preparation of the manager of the Qualified Opportunity Fund. This person or entity is tasked with managing the underlying investment and asset, and you want to ensure your investment is in experienced hands.
• There is always the potential for a QOF to disperse and dissolve early which could mean an investor does not receive all of the potential tax benefits; make sure you understand how your investment could be impacted and how to move forward if the original investment hold period changes.
• As many Qualified Opportunity Zones lie in areas with little to no investment history, it is imperative to understand the risks specific to the asset, as well as potential unforeseen factors that could lead to a displaced outcome.
• In many cases, the investment made within a QOF will be real estate assets such as apartment buildings, offices, or farmland. Investors should consider whether the underlying asset fits well within their portfolio.

Again, it is imperative to speak with your tax advisor before investing in a QOF.

Final Thoughts

AcreTrader is able to offer investment in farmland opportunities in Qualified Opportunity Zones through the AcreTrader platform. All investment involves risk, including the loss of your entire principal. Investing in agricultural land through a QOF is an avenue for investors to participate in farmland real estate through a tax-advantaged vehicle. An ag-focused Opportunity Zone Fund can bring new sources of capital to farmers, increase economic growth in the local community, and provide compelling incentives for investors. Farmland with development opportunities for permanent crops, such as fruit and nut trees, vineyards, and timberland stand to benefit from this structure, if applicable. Given the tax implications with this investment strategy, all investors should consult with their tax attorney or other financial and tax advisors prior to making a QOF investment decision.

Take a look at our offerings page to see past, current, and upcoming investment opportunities. See the offering page for more complete details, including the Private Placement Memorandum that contains the complete information on risks, finances, and fees.

The information contained in this article is not intended and should not be construed as tax advice in any manner. It is intended to demonstrate the ways in which a potential investor could receive tax benefits and the applicability of such benefits is not guaranteed for any individual investor. Investments in a Qualified Opportunity Zone include risks such as, although not necessarily limited to, complex tax treatments, lengthy holding periods, and are made in economically distressed areas.

The above content is not intended to be a comparison between products, but is intended for general, educational and informational purposes only. Any performance noted is historical and there is no guarantee any trends will continue. All investing involves risks, including the complete loss of principal. Diversification does not guarantee a profit or protect against loss in a declining market. It is important for each investor to review their investment objectives, risk tolerance, tax liability and liquidity needs before investing. Investment vehicles have differences in fee structure, risk factors and objectives. Investments are considered speculative, involve a high degree of risk and therefore are not suitable for all investors.

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