In 2017, the new federal tax law created Opportunity Zones with the goal of directing investment, development, and improvement in distressed communities around the United States. An Opportunity Zone is defined by the IRS as an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. As you may expect, Opportunity Zones are now, rightfully, getting a lot of attention.
1031 Exchanges and opportunity zones are similar in that they both offer investors an opportunity to defer taxes due on gains. While 1031 exchanges are limited to investment property and must follow designated 1031 guidelines as outlined here, opportunity zone investments can be made up to 180 days from the date the gain occurred and are not limited to investment property. There could be situations in which an opportunity zone investment would make more sense for a real estate investor considering a 1031 Exchange - however I feel most real estate investors will continue to utilize 1031 Exchanges when possible. I think many investors in opportunity zones will be investing gains from other appreciated assets, such as stock and businesses.Potential Benefits of an Opportunity Zone Investment
Investing in a qualified Opportunity Zone allows for a tax shelter of capital gains realized from any source (ie: sale of appreciated stock, sale of a business)—not just real estate—as long as the gains are invested within 180 days from when the gain is incurred. By investing gains into an Opportunity Zone, which typically occurs through an Opportunity Zone Fund, an investor may realize three tax benefits:
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The capital gains tax due that is attributable to the amount of gains invested in the fund is deferred until the year 2027.
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A portion of capital gains tax that would be due could be forgiven, as gains invested for 5 years receive a 10% step-up in basis, and gains invested for 7 years receive a 15% step-up in basis.
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Any gains resulting from the investment are not subject to capital gains tax, provided the investment is held for at least 10 years.
Opportunity Zone Benefits: An Example
An investor sells stock for $1 million. The gains attributable to the sale are $100K. Normally, the investor would have a tax payment due in the year the $100K of gains was realized. For this example, let’s assume the tax due would be $25,000. Instead of paying the tax, the investor decides to invest the $100K in gains into an Opportunity Zone Fund, in 2020.
By structuring the investment this way, the investor delays their tax payment until 2027. Then, in 2027, the investor will receive a 15% basis step-up, assuming the investor is still in the same tax bracket and that tax rates have not changed. At that time, the investor would owe $21,250 in tax. In this example, the investor reduced their tax by $3,750 and delayed paying the tax for seven years. Additionally, if the $100K investment grew to any amount, all of those gains would be tax free.
Interested in Learning More?
There are many tax incentives to investing gains into an Opportunity Zone. However, for the investment to benefit an investor, tax incentives alone are not enough. It is crucial to evaluate the underlying investment itself, and we can help you do that.
Currently, the Opportunity Zone Funds we have access to and all of the ones we have reviewed are available to accredited investors only (annual income of $200K (single) or $300K (joint), or a net worth of at least 1 million, excluding primary residence).
Our firm has access to a variety of OZ funds that we can discuss with our clients. If you would like to know more, please don’t hesitate to call us.
In the meantime, check out our current Availability Report here!
