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.1
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 lofty 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 (“QOF”) within 180 days of the gains being realized.
(Learn the basics about Qualified Opportunity Zone Funds in Cadre’s 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.2
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 QOF 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.3
“Taken together, these benefits can materially improve an investor’s total tax liability and investment return,” notes Charlie Anastasi, an investment professional with Cadre. “Holding a successful Opportunity Zone investment for 10 years is estimated to generate potentially twice the after-tax profits compared to a standard taxable portfolio appreciating at the same rate.’’
(Learn more in Cadre’s Opportunity Zones Tax Reporting How-To.)
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 QOF structure.4
Anastasi points out that the potential tax benefits are magnified by higher investment returns, making investment selection paramount.
In its approach to investing in Opportunity Zones, Cadre uses a strategy of proactive market selection, working with top-tier operating partners, and serving as an active fiduciary 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 $50 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 manager smay 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”