Opportunity Zone Tax Benefits: What Role Does the Roof Play?

by Bill Lomel and Robert L. Brown, CPA

It’s that time of year again — chances are you’re thinking about taxes. If you’re an investor with unrealized capital gains, you have a new investment opportunity to avoid paying some taxes on those capital gains. You can invest them in properties and businesses in areas called federal Opportunity Zones.

Here’s how the new Opportunity Zones program helps both investors and struggling communities, and how commercial roofing factors in. (Note: This is not tax advice, just an overview of the program! Please consult tax and legal professionals for advice on how the program can benefit you.)

Federal Opportunity Zones in Georgia and metro Atlanta

Opportunity Zones are an economic development tool that was added to the tax code by the Tax Cuts and Job Acts of 2017.

Click on either image to explore Opportunity Zones locations in interactive maps. Each provides somewhat different information. Sources: Invest Atlanta/ www.policymap.com (left) and Economic Innovation Group (right).

They provide preferential tax treatment in specific geographic areas that are experiencing economic distress (based on census data). Investors who invest capital gains in new investments in these zones defer paying taxes on those gains until they sell or exchange the investment or on December 31, 2026, whichever comes first.

If investors hold their Opportunity Zone investment for five years, they not only defer paying capital gains tax but save 10% on the capital gains tax they would have paid. And if they hold the investment for seven years, the tax savings increases to 15%.

Additionally, if investors hold the Opportunity Zone investment for 10 years or longer, they will pay no capital gains at all on the sale of the investment — Opportunity Zone investment gains are permanently excluded.

The goal? To drive funds into areas where investors typically do not invest.

There are Opportunity Zones in every state — 8,700 in all — including many in metro Atlanta and even more in Georgia’s rural areas. Check the interactive maps for specific zone locations, including intown neighborhoods like the West End (adjacent to the Mercedes-Benz stadium) and suburban areas like Norcross, Smyrna, Newnan, and Douglasville.

The investment potential in distressed areas is enormous. Currently, U.S. investors have trillions of dollars in unrealized capital gains in stocks and bonds alone. Both short- and long-term capital gains qualify for Opportunity Zone investments.

A Qualified Opportunity Fund: the program’s investment vehicle

Investments in Opportunity Zone projects need to be held in a new type of partnership or corporation called a Qualified Opportunity Fund (QOF).

Investors can form new QOFs or invest in existing QOFs — some Google searching will turn up dozens of existing QOFs and QOF projects looking for investors, including projects spearheaded by public, private and nonprofit groups.

Invest Atlanta, the economic development authority for the City of Atlanta, for example, is looking for QOFs that want to be involved in six different social impact projects. For a list of national projects focused on affordable housing, the nonprofit National Council of State Housing Agencies (NCSHA) provides a continually updated guide.

Be aware that the federal Opportunity Zones we’re discussing here are different from the State of Georgia Opportunity Zones that provide job tax credits. This federal program is administered by the U.S. Department of Treasury and not the State of Georgia.

How much tax savings can Opportunity Zone investors expect?

As mentioned above, the potential tax savings depends on how long you hold the new asset and the capital gains you realize when you sell or exchange it.

As an example, let’s say you have $750,000 in taxable capital gains to invest. If you’re in the 35% tax bracket that means you will pay about $262,500 in taxes on your capital gains. If you invest all of the gains in a property in an Opportunity Zone and sell or exchange the property in five years, your tax liability on the capital gains is reduced by 10% to $236,250 or a savings of $26,250. If you hold the property for seven years, your tax liability is reduced by 15% to $223,125 or a savings of $39,375.

After year seven, your original capital (the capital gains) stops receiving new benefits. But if you hold the property for 10 years or longer, when you sell it you will not owe any taxes on your capital gains from the sale or exchange as long as you have “significantly improved” the property. The precise definition of “significantly improved” is still being worked out.

See The Tax Benefits of Investing in Opportunity Zones from the Economic Innovation Group for comparative examples.

Keep in mind this new program does not continue in perpetuity. The Opportunity Zone program expires on December 31, 2026, along with other provisions of the Tax Cuts and Job Acts of 2017, unless a new law extends the deadline. To get the full benefit of a QOF, invest by December 31, 2019 — the seven-year mark. After that, you’ll start to lose out on some of the benefits.

Do all investments in an Opportunity Zone qualify? 

Only capital gains invested in new assets through QOFs are eligible for preferential tax treatment. Other invested funds are not. And as you might expect, investments in some assets qualify and some don’t.

Investments in new real estate development and in existing properties that investors substantially improve, including installing new roofs, will most likely qualify.

Investments in start-ups and infrastructure that serve the local community may also qualify, and so may existing local businesses or initiatives that are funded through QOFs. But vacant land and “sin businesses” like bars, massage parlors, and tobacco shops are excluded.

The Treasury Department and IRS are still working out some issues in addition to the definition of “significantly improved.” Seek the advice of a lawyer and tax professional if you’re interested in any of these tax advantages.

How to work with a roofing contractor for an Opportunity Zone project

Significantly improving a commercial property almost always includes improving the roof. Protection starts at the top, after all. So as with any property, partnering with a qualified roofing contractor is critical for your return on investment. If a property has been neglected or is a historical building, it’s even more important. Brick buildings in particular often have special situations to address such as waterproofing.

It’s a good idea to have an expert evaluate the roof before you buy the property so you know what kind of roof investment to expect.

How much should you spend improving the roof? Here’s where decisions about investing in Opportunity Zone properties may differ from decisions about other properties.

Replacing the existing roof with a high-quality roof could not only substantially improve the property value and the Opportunity Zone but also help you realize more tax savings when you keep it for 10 or more years. Remember, taxes from capital gains on the sale of an Opportunity Zone investment are permanently excluded.

Your roofing contractor will want to know your goals for the property — are you planning to improve it and sell it in under 10 years or are you planning to hold onto it to get the best possible tax break? The intended use of the property matters, too. The type of roof you should install may be different depending on if it will be used for retail, a school or a manufacturing facility.

Roof slope, rooftop equipment and traffic, wind zones, fire rating requirements and other re-roofing considerations all come into play as well, as they do with any re-roofing decision.

Other tax changes that impact commercial property owners who want to re-roof

Whether or not you have capital gains to invest, the new tax law offers advantages for commercial property owners. 

The depreciation life of a commercial roof has been reduced to a much more realistic time frame — from 39 years to 25 years. Commercial roofs are also now included under Section 179, which allows you to deduct the full purchase price of qualifying equipment during the same tax year. The Section 179 deduction has now been doubled from $500,000 to $1 million, making it possible to deduct the entire cost of some roofs in one year instead of depreciating them over time.

In addition, small and medium-sized businesses can benefit from the increase in the phase-out threshold or the point at which your tax credit for improvements begins to phase out. See our post 4 Ways the New Tax Law Can Benefit Commercial Roof Owners for more details.

No matter how you look at it, a commercial roof is an important investment and asset. Smart planning can make your investment a tax advantage, too.

Partnerships and improving communities

It’s not often that investors are presented with an opportunity to defer, reduce, and even avoid paying capital gains taxes entirely while also helping to transform communities in need. The Opportunity Zone program is well-named.

An experienced roofing contractor who understands how the tax code works — in addition to how to install high-quality roofing systems — is the best partner for your unique situation.

Many thanks to Robert L. Brown, CPA, LLC for his assistance with this post. Robert works with Sentry Roof Services providing accounting and advisory services.

Skyline photo credit: Georgia National Guard photo by Capt. William Carraway