Introduction:
Should investors invest in a Qualified Opportunity Zone Fund? Find the answer here.
What exactly is an Opportunity Zone?
An Opportunity Zone is a town dominated by the state and certified as eligible for this program by the Treasury Department. The Treasury Department has designated zones in each of the 50 states, as well as Washington, D.C., and U.S. territories.
There are roughly 8,700 Opportunity Zones around the country. A list is available from the U.S. Department of Housing and Urban Development.
How does this program function?
To postpone a capital gain (including net 1231 gains), a taxpayer must invest the realized capital gain dollars in a Qualified Opportunity Fund within 180 days of the sale or exchange of appreciated property.
The taxpayer may invest both the return of principal and the recognized capital gain. Still, only the portion of the investment related to the capital gain is eligible for the tax exemption on future appreciation of the Opportunity Zone investment, as discussed further below. The Opportunity Zone program permits the sale of any appreciated assets, such as stocks, with the proceeds reinvested in a Qualified Opportunity Fund. There is no urgency to invest in a comparable property to delay the gain.
It is important to note that a taxpayer who receives a reported capital gain from a flow-through entity, such as a partnership, S-corporation, or trust/estate, has 180 days from the calendar year to invest in a Qualified Opportunity Fund.
Suppose a partnership entity realizes a capital gain in March. In that case, each partner’s 180-day triggering date is December 31 of the same year. Each partner has until approximately June 28 of the following year to make their Qualified Opportunity Zone investment.
Opportunity Fund for Qualified Individuals
A Qualified Opportunity Fund is an investment entity constituted as a corporation or a partnership to invest in Qualified Opportunity Zone property that holds at least 90% of its assets in Qualified Opportunity Zone property (other than another Qualified Opportunity Fund).
Like any other, a Qualified Opportunity Fund investment may gain or fall in value over the holding period. This investment may also provide revenue. Given that the program’s goal is to enhance specific locations, it is assumed that the fund will continue to invest in the property in which it is invested. Once the property modifications are completed, and the property is leased or sold to other parties, cash flow may occur.
These investments may include risk since Qualified Opportunity Funds are new income tax planning tools and new investment possibilities for taxpayers. The dangers, as with many other forms of investments, may include market loss, liquidity risk, and company risk, to mention a few. Because this investment may not be suitable for all investors, speak with your investment advisor before proceeding with such an investment to discover if it fits with your risk profile and investment diversification.
Qualified Opportunity Zone property is defined as property acquired after December 31, 2017.
The Qualified Opportunity Fund, in theory, must bring an additional property to the company to be used in the Opportunity Zone. A fund that acquires property currently in use in the zone will not qualify unless it undergoes significant modification. Over 30 months, significant improvement necessitates upgrades that surpass the Qualified Opportunity Fund’s original investment in the existing property. (Please remember that investment only pertains to the sum spent for the building.)
For example, suppose a Qualified Opportunity Fund buys existing real estate in an Opportunity Zone for $1 million. In that case, the fund has 30 months to invest more than the $1 million purchase price in property upgrades to qualify for this program.
A Qualified Opportunity Fund investment can save you money on taxes in three ways:
A taxpayer may elect to delay the tax on some or all of a capital gain if they invest in a Qualified Opportunity Fund during the 180 days beginning on the date of sale/exchange. Any taxable gain in a Qualified Opportunity Fund is not recognized until December 31, 2026 (due with the filing of the 2026 return in 2027), or until the fund’s interest is sold or exchanged, whichever comes first. Furthermore, the postponed gain can be lowered further, as stated below.
Tax basis step-up of 10% or up to 15% of deferred gains
A taxpayer who defers gains through a Qualified Opportunity Fund investment obtains a 10% tax basis step-up after five years and an additional 5% step-up after seven years. It should be noted that to benefit from the 15% step-up in tax basis fully, the taxpayer must have invested before December 31, 2019. The taxpayer will have kept the investment in the fund for seven years.
There is no tax on appreciation if the property is held in the Qualified Opportunity Fund for at least ten years, and the cost basis is equivalent to the fair market value on the date of sale/exchange.
The gain moratorium applies to any investment gain (for example, the sale of appreciated stock or a business). It is vital to understand that the tax can only be postponed until 2026. However, the tax savings may still be significant. There is no need for an intermediary to qualify for deferral, and the taxpayer has 180 days from the date of sale to invest the gains in a Qualified Opportunity Fund.
Good results come to those who wait, and then some.
The Opportunity Zone Program generally offers investors three potential tax benefits: deferred taxation of capital gains invested in a Qualified Opportunity Fund; partial elimination of tax on such deferred capital gains if the investment is held for at least five or seven years; and a federal income tax break on capital gains obtained upon the sale of a Qualified Opportunity Fund investment.
Investors who report capital gains on Schedule D and Qualified Opportunity Fund investments on Form 8949 initiate the tax deferment procedure. “The deferred capital gains will be included in the investor’s taxable income when the Qualified Opportunity Fund is disposed of or in the taxable year that includes December 31, 2026, whichever is later.” Some individuals believe that means you must pay taxes on December 31, 2026. “That is not correct,” he says.
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