In 2017, the Tax Cuts and Jobs Act was enacted and passed into law. The Act introduced Qualified Opportunity Zones to encourage sustained economic growth and investment in economically distressed areas.
More than 8,700 low income urban and rural census tracts nationwide have been designated as Qualified Opportunity Zones. Examples in Massachusetts include neighborhoods surrounding the train stations in Brockton, Lawrence, and Springfield. Interactive maps are available online.
This program comes with significant tax benefits for investors, including capital gains deferral, tax basis increases, and capital gain exclusions.
During 2019, the Treasury released a second round of the proposed regulations in order to clarify the nuances of the incentives, as well as reiterate the goal of the incentives: to reduce unemployment, relieve poverty, and boost economic activity and growth in the designated communities.
Opportunity Zone Tax Benefits for Investors
1. Capital Gains Deferral
This incentive allows for a temporary deferral of the tax on certain capital gains.
The taxpayer can sell qualifying appreciated assets (to an unrelated party) and defer any capital gain taxation by rolling that capital gain into a Qualified Opportunity Fund (QOF) within 180 days. The taxpayer must recognize the deferred capital gain by December 31, 2026, or when the taxpayer exits the fund, whichever comes earlier.
2. Tax Basis Increase
Initially, the taxpayer’s basis in the QOF is zero, but will increase by 10% of the deferred capital gain after the investment is held for over five years. After holding the investment for seven years, the basis is increased by an additional 5%, giving an overall step-up of 15% over seven years.
3. Capital Gain Exclusion
Appreciation in a QOF may also be permanently excluded from taxable income. After 10 years, the taxpayer can elect to step up the basis to 100% of fair market value when they sell the QOF investment on or before December 31, 2047. This means the entire gain would be exempt from federal income tax.
What Qualifies as a QOF?
The following constitute the characteristics of a Qualified Opportunity Fund:
- Investment vehicle that is either a domestic partnership or a domestic corporation
- Purpose of the fund must be to invest in qualified opportunity zone business property or stock/partnership interests in qualified opportunity zone businesses
- Hold at least 90% of its assets in qualified opportunity zone business property at two dates each year:
- Last day of the first 6-month period of the taxable year of the fund (typically 6/30)
- The last day of the taxable year of the fund (typically 12/31)
- Penalties are incurred each month it fails to meet the 90% requirement
The following do not qualify:
- Single member limited liability company investments
- Tiered or fund of fund investments (a qualified opportunity fund cannot invest in another qualified opportunity fund)
- Excluded businesses:
- Suntan facility
- Race track or other facility used for gambling
- Golf course
- Liquor store
- Country club
- Massage parlor
- Hot tub facility
Opportunity Zone Tax Benefit Example
Jan 1, 2019
|Jan 1, 2024||Jan 1, 2026||Dec 31, 2026||
Jan 1, 2029
|· Investor sells an investment for $200,000 resulting in a $100,000 capital gain.
· Within 180 days of selling their investment, they invest the $100,000 capital gain into a QOF.
|· Investor receives a $10,000 step-up in basis related to the original deferred capital gain since the taxpayer held the investment for at least five years.
· If the investor were to sell the QOF investment after five years, a$90,000 capital gain would be subject to tax.
|· Investor receives an additional SS,000 step-up in basis related to the original deferred capital gain since the taxpayer
held the investment for at least seven years.· If the investor were to sell the QOF investment after five years, an $85,000 capital gain would be subject to tax.
|· The deferred capital gain of $85,000 must be recognized no later than this date and tax is due.||· Investor would not owe any tax related to the appreciation of their investment in the QOF if sold since the taxpayer
held the investment for at least ten years.
10/19/18: First round of proposed regulations released
4/17/19: Second round of proposed regulations released
12/31/19: Last date to invest in QOF and receive a tax basis increase of 15% of deferred capital gain for holding > 7 years
12/31/26: Deferred capital gain must be recognized
12/31/28: Qualified Opportunity Zones expire
12/31/47: Last date to receive capital gain exclusion on sale of QOF investment
Investing in opportunity zones provides investors with a unique opportunity to bolster sustainable economic growth in disadvantaged communities while achieving significant tax benefits. This content is for information purposes only and should not be considered investment advice. Specific investing strategies should be discussed with your investment advisor.