According to a recent study, U.S. households are sitting on $3.8 trillion in unrealized capital gains in stocks and mutual funds alone. If you include U.S. corporations, which were estimated to have held $2.3 trillion in unrealized capital gains on their books at the end of 2017, the pot of potential capital eligible for reinvestment increases to $6.1 trillion. On top of that number is the untold amount of unrealized gains in other assets such as small businesses and real estate.
A Case for Realizing Capital Gains
Why sell now?
Thanks to a 10-year bull market, U.S. individuals are sitting on portfolios filled with appreciated stock positions. The S&P 500 has appreciated nearly 240% over the last 10 years, which means a $100,000 investment would now be worth roughly $340,000, creating $240,000 of unrealized capital gains.
Other investors, such as those who receive company stock as part of their compensation or through acquisition, may have one investment with an outsized weighting — this concentration may warrant portfolio rebalancing. To use a prominent example, Amazon stock has tripled in just the last three years.
Historically, selling these positions would trigger a material tax liability — the top tax bracket is 23.8% (plus applicable state tax) for long-term capital gains. Often, the prospect of a sizeable tax bill has stopped investors from taking action.
So, how should investors think about optimizing the tax-efficiency of their capital gains? Thankfully, the Tax Cut and Jobs Act of 2017 provides investors a new opportunity to significantly mitigate their tax liability by investing in Opportunity Zones.
Why should I invest my capital gains in Opportunity Zones?
Opportunity Zone investing can be a smart and prudent way to diversify away from public markets equity exposure into real estate while also deferring and reducing the normal 23.8% tax on those booked gains.
The program offers the potential for capital gains tax breaks on any recently sold investment — including stocks, bonds, a private business, or real estate — so long as the gains are rolled into a Qualified Opportunity Fund within 180 days of the gains being realized. However, numerous uncertainties remain and interpretive ambiguities may emerge (see Disclaimer below).
(Learn the basics about Qualified Opportunity Zone Funds in our Guide to Opportunity Zones.)
Beyond the tax benefits, Opportunity Zones offer a unique opportunity for investors to gain additional exposure to US real estate, an asset class that has outperformed the S&P 500 over the past 20+ years. At the same time, private real estate typically exhibits substantially lower volatility than the stock market.
How do Opportunity Zone investments help me defer or reduce my taxes?
Through the Opportunity Zone program, investors can:
- Defer taxes on capital gains reinvested in a Qualified Opportunity Fund until December 31, 2026 or the date on which the Opportunity Zone investment is disposed of, whichever is earlier.
- Reduce the amount of deferred taxes owed by up to 15%. The basis for capital gains reinvested in a Qualified Opportunity Fund is increased by 10% if the Opportunity Zone investment is held for at least five years, and by an additional 5% if held for at least seven years; as such, the amount of deferred taxes can be reduced by up to 15%.
- Eliminate tax on capital gains from the Qualified Opportunity Fund investment if it is held for at least 10 years.
How to begin investing in Opportunity Zones
The regulatory outlines of the Opportunity Zones program require an experienced team to ensure the combined success of the underlying real estate investments and the Qualified Opportunity Fund structure.
In its approach to investing in Opportunity Zones, Cadre uses a strategy of proactive market selection, working with experienced operating partners, and serving as an active investment manager for our investor partnerships. We believe the optimal Opportunity Zone investment strategy and deal structure align with our existing approach.
Through its Opportunity Zone program, Cadre offers investors the following advantages:
- Efficient Diversification. Access a series of Opportunity Zone investments with data-driven diversification across select markets and alongside experienced operating partners. Cadre seeks to avoid the risks associated with single asset, market, or developer strategies.
- Experienced Investment Team. While the program’s tax benefits are highly attractive, investments must be grounded in the merits of the real estate. The Cadre team brings over $45 billion of collective transaction experience at top tier investment firms, including roughly $10 billion of development experience across the U.S.
- Experienced Operator and Developer Network. Cadre has developed a pipeline of actionable opportunities within our target Opportunity Zone markets, driven by our network of over 300 local operating partners.
- Single-Asset Fund Structure. Since inception, Cadre has focused exclusively on structuring single-asset funds, which we believe is the optimal structure for Opportunity Zone investing. Leading law firms have noted that a traditional commingled fund structure with multiple properties is not a straightforward fit for the Opportunity Zone Program and that instead, fund managers may wish to create a separate fund for each property.
Economic Innovation Group, “Opportunity Zones Tapping Into a $6 Trillion Market, “ March 21, 2018. ↩︎
“Invest in the asset class that has outperformed the S&P 500 over the last 20 years” refers to the cumulative return (with full reinvestment of dividends) of an investment in the FTSE NAREIT US Real Estate Equity REITs index as compared to investment in the S&P 500 (using S&P Total Return data from CBOE) for the period from December 2000 – December 2018. Investments with Cadre are in private real estate interests and are materially different from investment in US equity REITs; real estate return data should not be used to estimate the return of Cadre investments. ↩︎
Insights by Cadre, ”Opportunity Zones 101: Guide to What Investors Need to Know,” Feb. 6, 2019. ↩︎
Insights by Cadre, “Opportunity Zones 101” ↩︎
The views expressed above are presented only for educational and informational purposes and are subject to change in the future. No specific securities or services are being promoted or offered herein.
This communication is not to be construed as investment, tax, or legal advice in relation to the relevant subject matter; investors must seek their own legal or other professional advice.
Performance Not Guaranteed
Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections are not guaranteed and may not reflect actual future performance.
Risk of Loss
All securities involve a high degree of risk and may result in partial or total loss of your investment.
Liquidity Not Guaranteed
Investments offered by Cadre are illiquid and there is never any guarantee that you will be able to exit your investments on the Secondary Market or at what price an exit (if any) will be achieved.
Not a Public Exchange
The Cadre Secondary Market is NOT a stock exchange or public securities exchange, there is no guarantee of liquidity and no guarantee that the Cadre Secondary Market will continue to operate or remain available to investors.
Opportunity Zones Disclosure
Any discussion regarding “Opportunity Zones” — including the viability of recycling proceeds from a sale or buyout — is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidances, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any, additional guidance, including future legislation, administrative rulings, or court decisions will have and there is risk that any investment marketed as an Opportunity Zone investment will not qualify for, and investors will not realize the benefits they expect from, an Opportunity Zone investment. We also cannot guarantee any specific benefit or outcome of any investment made in reliance upon the above.
Cadre makes no representations, express or implied, regarding the accuracy or completeness of this information, and the reader accepts all risks in relying on the above information for any purpose whatsoever. Any actual transactions described herein are for illustrative purposes only and, unless otherwise stated in the presentation, are presented as of underwriting and may not be indicative of actual performance. Transactions presented may have been selected based on a number of factors such as asset type, geography, or transaction date, among others. Certain information presented or relied upon in this presentation may have been obtained from third-party sources believed to be reliable, however, we do not guarantee the accuracy, completeness or fairness of the information presented.