In August 2020, Congress established a new opportunity zone for real estate investors and business owners with the designation of Hemp Opportunity Zones. As with other opportunity zones, these come with significant, long-term tax advantages to the investor.
This new type of opportunity zone could be an additional way for investors to benefit from tax advantages while gaining access to a budding industry. Learn what an Hemp Opportunity Zone is and the opportunity for investors in this market.
Opportunity zones, explained
An opportunity zone is intended to attract capital to low-income or undercapitalized areas of the United States as identified in the 2017 Tax Cuts and Job Act. Metrics such as the poverty rate and median income are used to classify census tracts as areas in need of economic stimulus.
One of the biggest advantages to a real estate investor is the eligibility to defer capital gains tax on a step-up basis. In addition, depending on the length of time the investment is held, from 5 to 10 years or more, investors are also eligible for anywhere from a 10% reduction in capital gains taxes from taxes earned in the opportunity zone investment.
Hemp Opportunity Zones, explained
Hemp, a non-psychoactive form of cannabis, was removed from the Controlled Substances Act with the 2018 Farm Bill. Any Cannabis sativa L. that has no more than 0.3 percent of the psychoactive compound delta-9-tetrahydrocannabinol (THC) on a dry weight basis is therefore legalized federally. Hemp is often used as food for humans and animals, for creating commercial products like textiles or rope, and even bioplastics or biofuel. It's also used to create a durable building material called hempcrete, which is nontoxic; mold-, fire-, and pest-resistant; and carbon negative, among other benefits.
A CEO of a state (the governor) is able to nominate an opportunity zone for hemp designation if the area is facing economic obstacles due to lack of resources, has mutually reinforcing state local or private aid, or is an area poised for economic growth that needs access to a larger commercial hemp market and will result is the highest rate of return for investing.
While many other opportunity zones focus on urban development, 40% of the nearly 9,000 communities designated so far are rural. Since hemp will grow in most parts of the country except arid desert and high-elevation mountainous regions, most of these areas have the potential to become Hemp Opportunity ones.
Hemp is a viable commercial crop. A Cornell University study found hemp production has the potential to easily match the profits of most other commodity grain crops and can potentially be as lucrative as highly profitable vegetable crops. It is also ideal for organic farming practices since it is pest- and disease-resistant, has minimal nutrient needs, and grows quickly to outcompete weeds. That means farmers don't need expensive pesticides, herbicides, or fertilizers.
Although hemp is now legal, it can still be difficult to source commercial funding for start-up costs or when purchasing a property for hemp farming. You should have alternative funding sources lined up for this type of investment. Finding a market to sell the crop can also be hard, but keep in mind: This could also present an opportunity. Hemp Opportunity Zone tax credits do apply to hemp-related businesses, which means you could qualify for the tax advantages by participating in the industry.
The bottom line
As a real estate investor, you do not need to be a farmer to qualify for these tax advantages. Instead, find a qualified Hemp Opportunity Zone Fund (OZF) that you can roll qualified capital gains into. As with any OZF, make sure to do your due diligence on the management of the fund, business plan, and market before rolling any capital gains into the fund. But those investors looking for an alternative asset class could see major opportunities in this emerging market.