Investment Decisions

May 23, 2019 by Peter Maclennan Leave a Comment

The Opportunity Zone

Qualified Opportunity Zones

Established by the IRS to incentivize investment in low-income areas, the Opportunity Zone program is relatively new, and many investors are still unfamiliar with the benefits it provides. As of April 2018, the IRS offers tax benefits on long-term real estate investments purchased within Qualified Opportunity Zones. So what does this mean for long-term investors? Today we dive into the basics of Opportunity Zones and their three major draws.

What’s an Opportunity Zone?

Qualified Opportunity Zones or QOZ are economically distressed areas in which the government has designated certain tax incentives for investors. Typically, this means a capital gains investment is tax-deferred and the deferred gain is eligible for a partial exemption after five years or more. As described on IRS.gov website:

An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.”
https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

See a map of Qualified Opportunity Zones

The preferential tax treatment described above only applies to purchases made with capital gains, and only for investment properties. In other words, homebuyers who plan on living in the house are ineligible for preferential tax treatment even if it is within an Opportunity Zone.

In order to establish an investment in an Opportunity Zone, investors must establish a Qualified Opportunity Fund (QOF) as a vehicle for investment property funds.

EIG.org provides a great resource for understanding Opportunity Zones.

Why invest in an Opportunity Zone?

1. Deferred tax

Okay, this one is obvious. After all, deferred tax is the primary incentive to investors, and is effective immediately upon investing.

Investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026.”
https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

This means that the investor has seven full years to defer on the reinvested gains before tax is owed. An investor may be able to defer taxes further with a 1031 exchange before the 2026 deadline.

2. Tax exemptions

In addition to deferring taxes, Opportunity Zones incentivize long-term investments by adjusting the basis on which tax is owed:

If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.”
https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

This is where things get good. The tax-deferred gains you invested are eligible for 15% exclusion after seven years, meaning you only owe tax on 85%. Additionally, if the investment is held for ten years, it is eligible for a step-up in basis to the fair market value. If the property was sold shortly after the ten-year mark, the investor would be paying no capital gains tax on appreciation. This is a huge incentive for someone already interested in long-term investment.

3. Economically growing areas

Opportunity Zones were designed to help boost economically distressed areas by incentivizing long-term investors with tax benefits. The first zones were designated on April 9, 2018, so we must wait to see if they will offer the long-term economic development expected.

However, what is expected through the program is that the influx of new investments will drive an increase in property value throughout the zone. Investors realize the greatest gain if they establish funds early and stay invested long-term while the property values continue to increase. It is almost a self-fulfilling prediction, but one that benefits the early investors most.

Find a Real Estate Expert

Now that you know more about Opportunity Zones and the advantages they can provide, you are well on your way to making an informed and financially successful investment. Having a knowledgeable agent to assist you will make your process smooth and your returns as high as possible.

To reach Peter Maclennan please call 925.385.8798 or email at peter@maclennaninvestments.com.

This post is for informational purposes only. Contact a tax professional prior to making investment decisions.

July 15, 2014 by Peter Maclennan 1 Comment

Calculating Net Operating Income or NOI

Calculating NOI graphic
It seems like each industry has their own acronyms. The same is true for real estate.

In real estate, the letters NOI stand for Net Operating Income. The net operating income is a number on paper 9 times out of 10. It is not an actual figure that will show up in an investor’s bank account nor is it the number that will be used for tax purposes. NOI is useful in comparing the returns of various properties and for determining if a property is financeable. Think of NOI as the return a property would generate if it was purchased for all cash and regardless of taxes and depreciation.

Actual vs. Pro Forma

NOI can be calculated on an actual basis with the actual rents and the actual expenses. NOI can also be calculated on an expected or pro forma basis based on future estimated rents and estimated expenses. NOI is calculated on an annual basis in most cases.

Start with Income

To begin the calculation of NOI begin with the annual gross rental income for the property. Gross rental income is all the expected income from the property. If the property is a NNN property this will include CAM reimbursements.

Vacancy

Next you will need to deduct vacancy expenses. Vacancy expenses are an estimate of the amount of time that a property will be vacant in any given year due to tenants moving or not paying their rent. Usually this is expressed as a percentage of time. A property in a desirable location may have a low vacancy factor of 5% of the time. Another property in a questionable location may have a much higher vacancy factor and may be empty for 25% of the time or more.

By multiplying the vacancy factor by the gross income you arrive at the vacancy expense. Next you subtract the vacancy expense from the gross income. This will give you the Effective Rental Income.

To the Effective Rental Income you add Other Income. Other Income is usually miscellaneous income from parking fees, laundry, billboards, etc. Now you have arrived at the Gross Operating Income.

Minus Expenses

From the Gross Operating Income you subtract the property’s Operating Expenses to arrive at the Net Operating Income. Operating Expenses include all cash expenses paid to keep the property running at maximum efficiency. They will include property taxes, property insurance, management fees, utilities, advertising costs, accounting fees, legal fees, licenses, and other expenses.

Using NOI

NOI is used to calculate a properties Cap Rate (capitalization rate) for properties. NOI is also the number most lenders use to determine if a property has an adequate debt service coverage ratio (DSCR or DCR) to qualify for a loan.

NOI is a useful tool in helping investors analyze and compare investment properties.

January 11, 2011 by Peter Maclennan 1 Comment

Risk: Getting Your Money Back Guaranteed?

I have been reading Investing for the Future by Larry Burkett on investing principles. I was struck by the author’s clarity in defining risk.

Almost without exception the degree of risk is rated based on the guaranteed return of the principle, not how much earnings the investment might yield.

The key factor in evaluating an investment’s risk is: Will I get my money back?

An investment that could lose lots of money, should provide the investor with a greater reward for their willingness to take that risk. Conversely, “safe” investments provide less reward to investors, because they have a greater certainty of getting their money back.

This explains why savings accounts are bearing such a low rate of return. The federal government has guaranteed that savings accounts up to $250,000 will be made whole, by the FDIC. Investors in savings accounts are taking almost no risk, so they get almost no reward or return.

If you are interested in earning a higher yield on your savings, please feel free to contact me at (925) 385-8798.

May 21, 2010 by Peter Maclennan Leave a Comment

The Hidden Tax on Savers

Occasionally I pop over to Yahoo! Finance to check on the stock market’s behavior for the day. Once of the other features on the website is commentary from financial advisors.

Today, Laura Rowley had an article entitled Starving for Yield on Savings. She writes:

Americans who chose to save instead of buying homes they could not afford or cashing out their equity to splurge on luxuries during the real estate boom need a Robin Hood at the Fed, because they’re the ones getting robbed to pay for the recovery. Conservative places to park cash — savings, money markets and certificates of deposit — are still paying well below the inflation rate of 2.2 percent. As of this week, savings accounts are averaging returns of 0.20 percent; one-year CDs are yielding 0.77 percent, according to the Federal Deposit Insurance Corporation.

“The Fed is determined to keep rates very low, and while it’s painted as fiscal stimulus I think it’s really a stealth bailout of the banks,” says Richard Barrington, a certified financial analyst and expert with the bank comparison site Money-Rates.com. U.S. savers have lost $140 billion in purchasing power to inflation over the 12 months ending in March, according to a Money-Rates study released last month.

A Hidden Tax

Effectively, the government through the Federal Reserve has placed a hidden “tax” on those of us who save money. The saver’s hard earned cash is being used by the government to grow the balance sheet of banks across the country.

I was introduced to this idea through a Maura O’Connor, a veteran real estate attorney speaking at an event in Oakland, CA.

The tax takes money from the savers and investors and transfers it to the banks. Banks use the deposits in savings accounts, CD’s, and money market accounts to borrow 10 times the deposited amount from the Federal Reserve at 0.25%. The banks then invest that money in US Treasuries and earn 3% on the larger amount.

Would you pay $3.50 to earn $26.50? I sure would! And the banks will too!

Real Estate As An Alternative

While we could debate the ethical nature of this scenario, we won’t do that here. The question for the savers becomes: Are you going to take this?

If you have been keeping your money “safe” in a CD, money market, or savings account, you have alternatives to the low return you are getting on your cash. There are a variety of real estate investments that you could own that would generate a higher return than what you are getting now. They also are a better hedge against inflation than cash.

If you are interested, please call me at (925) 385-8798.

P.S. You can invest money in IRA accounts as well.

925.385.8798

The Opportunity Zone

What’s an Opportunity Zone?