The Qualified Opportunity Zone (QOZ) scheme is perhaps one of the most significant tax reductions real estate investors will ever encounter. Tax Cuts and Jobs Act of 2017 be eligible opportunity zones were established to encourage economic growth and job creation in economically disadvantaged areas.”
A person who invests in one of the Qualified Opportunity Zones is entitled to both deferral and forgiveness of taxes. Investing in a Qualified Opportunity Fund means that anyone who realized a capital gain in 2018 through stocks, art, trading, real estate, or any other source may be eligible for these tax advantages (QOF).
Using a real-world example, I will explain how these tax advantages operate.
Your accountant has just computed $150,000 in short-term profits and $300,000 in long-term gains for your 2018 tax bill. At the highest federal level, short-term profits are taxed at 37 percent, while long-term gains are taxed at 20 percent, bringing your total tax burden to around $115,000. However, if you invested all of your earnings ($450,000) in a Qualified Opportunity Zone Fund, you would owe no tax on this amount this year.
Both long-term and short-term capital gains are deferred entirely for QOZ fund holders. You don’t have to balance earnings against losses on your individual tax return. For instance, if one of your assets earned $300,000 and another investment lost $300,000, you may choose to invest the $300,000 gain and report the $300,000 loss on your 2018 tax return. You will be compelled to pay these taxes someday, but not until 2026. Depending on your investment year, you may be required to pay no more than 85 percent of your current tax due.
The most attractive feature of the tax cut is that the invested capital grows tax-free regardless of how much it earns, but it must be supported in a Qualified Opportunity Zone for at least 10 years. For instance, if the $450,000 investment increases to $2,000,000 after 15 years, you would owe no taxes on the profit.
Are All Capital Gains Eligible for Opportunity Zone Funds?
Yes, all capital gains are eligible for the tax advantages of a Qualified Opportunity Zone Fund, but the timing of this investment makes it complicated. The rule stipulates that capital gains must be invested within six months after recognition. However, the definition of recognition varies depending on your earnings source.
Partnership gains are reported at the time of payment or after the partnership’s fiscal year. Anyone having 2018 partnership earnings has until the end of June 2019 to use the Qualified Opportunity Zone tax credit to conceal such gains.
If the capital gain resulted through the sale of shares or a company, the date of purchase determines when the six-month period begins. For instance, if you sold shares of stock in May 2018 and produced $100,000 in capital gains, you are outside the six-month window, and these earnings are not eligible for QOZ treatment. If your firm was sold on November 15, 2018, you have until May 14, 2019, to invest the proceeds in a QOZ fund.
Managing expiring gains is difficult because you must immediately do due research on possible QOZ funds and choose a fund in which you feel comfortable investing before the payment expires. Adding to this intricacy is that QOZ fund operators may only accept funds when they have a specific purpose, which means they ask for cash when they locate a bargain.
The difficulty of determining when funds will be received is not favorable for investors with expiring profits. However, not be concerned since this is not the last investment chance. Since QOZ funds will continue to invest actively until 2026, there will be many more chances to align profits with investment opportunities.
The most excellent position for an investor to take advantage of this tax deduction is to harvest profits at any time since this eliminates the complex timing factor. For instance, if you held a liquid asset that has significantly risen in value, you would hang on to it while doing QOZ fund due diligence and then sell it when the QOZ fund is ready to accept your investment.
To be clear, only invested funds are eligible for the tax exemption. Simply contributing to a fund does not qualify it for the tax advantages. This should not be an issue for investors with total schedule flexibility, although they may have to wait a long. Finding economically feasible transactions in QOZ zones is challenging since the borders were often drawn around financially depressed regions.
However, many QOZs are transitional districts on the route to development, and money will undoubtedly flow there initially. Our staff has been concentrating on these communities for the last 10 years. We feel this provides a significant edge in the QOZ market, but it requires time and perseverance to identify high-quality bargains.
Working capital is a technique fund managers may use to increase the flexibility of collecting capital gains, and our QOZ Fund will have access to this resource. Fund management may call money in advance of a project’s need, so long as the manager has a purpose for the capital, a documented plan to deploy it, and the amount is invested within 31 months.
An investor with an invalid gain may be eligible to join a fund early through this provision. However, if the cash is not really invested within the permitted period, the fund may lose its designation as a Qualified Opportunity Zone Fund; thus, managers must be sure a transaction will occur before taking contributions in this manner.
For instance, we are now negotiating a contract to build housing units in three stages. We will immediately request financing for the first phase and have the option to request capital for the second and third stages in advance of when we need it. This enables the investor to lock in their tax savings, which conforms with the law since we have a purpose.
In addition, since we are not currently using the funds, we will not collect any fees until it is appropriate. Complying with fund regulations and balancing the interests of different tax circumstances may be difficult for managers, but the tax advantages are too significant to ignore.
Qualified Opportunity Zone Funds are investments with a ten-year horizon or more, and not all returns will be the same, so take the time to get acquainted with the fund management. Qualified Opportunity Zones’ tax benefits do not alter real estate’s foundations, and no one should invest just to reduce their tax liability. Evaluate the offer based on its merits; if you enjoy it on a pre-tax basis, you’ll like it after taxes.
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