Are Opportunity Zones the talk of the town in your local Real Estate circles? No?
While it’s no surprise that this part of the tax code is not yet well known, many savvy investors are jumping at the opportunity of the tax savings that it can provide.
What is an Opportunity Zone?
According to the IRS.gov website, “An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment….”
These opportunity zones were designated through coordinated efforts between State and local governments in identifying these economically-distressed areas.
Opportunity zones were added to President Trump’s “Tax Cuts and Jobs Act” in December 2017. Specifically the “Investing in Opportunity Act” created the Opportunity Zones.
This Act aims to help reinvigorate these economically depressed areas. Being part of Trump’s plan, it shouldn’t be any surprise that the intent of this program is to recruit private capital investment for this purpose.
Who Can Benefit from Investment in Qualified Opportunity Zones?
Entrepreneurs and investors in any asset class can benefit from investing in a Qualified Opportunity Zone.
This is different than a 1031 exchange (where you can only defer tax on real estate investment gains). Opportunity zones allow for investment into real estate and businesses in QOZs.
Let’s take three common scenarios that plenty of investors or entrepreneurs may have experienced in the past year.
- 8 years ago you invested $100,000 in the stock market. Since then the stock has made significant gains and you find yourself with a new portfolio value of $1,000,000. You have a capital gain of $900,000. Dividends are ok, but you’d like to cash out of this market but you hate to pay tax on that gain.
- You’re a Real Estate Investor who has a portfolio of properties. Your planned investment horizon is fast approaching and you’re going to cash out to maximize your return. You will have a significant capital gain of $2 million when this occurs.
- You’re an Entrepreneur who has been building a marketing company for the past 10 years. Out of nowhere, you’re approached by a major media company who offers to buy you out. It’s an offer that you can’t refuse. You’ll walk with a $15 million capital gain after the sale.
Writing that check to the IRS hurts! Investing in opportunity zones affords several benefits if you follow the rules. If you want to get the full benefit, this is a long term investment.
Here is a broad overview of Opportunity Zone benefits:
- Tax deferment on your invested capital gain until the earlier of which the investment is sold or December 31st 2026.
- For purposes of determining gain or loss, you’ll get a 10% step up in tax basis for investments held at least 5 years prior to December 31st, 2026.
- An additional 5% step in tax basis for investments held at least 7 years prior to December 31st, 2026.
- Investments in a QOF that are attributable to capital gains held for at least 10 years get a step up in basis to the fair market value of the investment on the date of sale or exchange.
Yes, read that last one again. That last one is big. Follow the rules, and you could be very happy that you invested in a QOF.
There are rules involved, of course. First, you must create a qualified opportunity fund (QOF).
- To become a Qualified Opportunity Fund, an eligible corporation or partnership self-certifies by filing Form 8996, Qualified Opportunity Fund, with its federal income tax return.
- Next, you must invest in a QOZ within 180 days of realizing the gain that you wish to defer tax on.
- You’ll also need to significantly improve the asset you purchase within 30 months. This applies to the basis in the improvement only, not the land. You’ll essentially have to double your basis in the improvement.
We’re just scratching the surface above. It’s critically important to consult your tax advisor before you go out and buy property in a QOF. If you do have a significant gain and want to take full advantage of the opportunity inherent in this program, you’ll need to purchase your investment before the end of 2019.
Communities Benefit from Opportunity Zones
The Qualified Opportunity Zone program aims to drive private capital into communities to help reinvigorate them. Many of these communities could be in your own backyard.
Before you go ahead and jump in consult your tax advisor, and make sure that you have an experienced local real estate agent on your side that can help guide you through picking out a Qualified Opportunity Zone property or business.
“IRS Provides Much Needed Guidance on Opportunity Zones through Issuance of Proposed Regulations.” Gibson Dunn, 22 Oct. 2018, www.gibsondunn.com/irs-provides-much-needed-guidance-on-opportunity-zones-through-issuance-of-proposed-regulations/.
“Opportunity Zones Frequently Asked Questions.” Internal Revenue Service, www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions.