When the Tax Cuts and Jobs Act (TCJA) was introduced, primary focus was placed on the decrease in tax rates, qualified business income deductions and changes to the itemized/standard deductions. Now that these have been addressed, a closer look suggests several “opportunities”. Once such, “opportunity” is The Opportunity Zone program.
The Opportunity Zone program was created to encourage economic developments and job creation in select distress communities by providing attractive tax incentives (includes tax-free treatment of capital gains) for those who invest in (property) the zone.
Opportunity Zone Designations
The TCJA allows for the designation of certain low-income community population census tracts as Qualified Opportunity Zones (QOZ) (as described in Code Sec. 1400Z-1).
Investing in an Opportunity Zone
By investing in an Opportunity Zone, capital gain taxes are deferred or reduced by rolling in the capital gain from a sale into a Qualified Opportunity Fund, set up for investing in eligible property located in a QOZ.
Qualified Opportunity Zone (QOZ) Property
- QOZ Business Property – Tangible property used in a trade or business that is acquired by purchase after December 31, 2017. The original use of such property commences with the QOF or the QOF substantially improves the property.
- QOZ Business – A trade or business in which substantially all of the tangible property owned or leased by the entity is a QOZ business.
- QOZ Stock – Stock of any domestic corporation that was acquired by the QOF after December 31, 2017 and at the time such stock was issued, and during substantially all of the QOF’s holding period, is a qualified QOZ business.
Tax Benefits of a QOZ Investment
Reinvesting the capital gain of an appreciated asset into a QOF can either defer the capital gain or reduce the tax liability. It can also eliminate capital gain on the QOF itself. The longer the investment is held, the better the tax savings.
- Held Less Than Five Years – Payment of the capital gain is deferred until the date that QOF is sold.
- Held Five to Seven Years – Payment is deferred until the date the QOF sold, plus 10% of the deferred capital gain is cancelled.
- Held Seven to Ten Years – Capital gain is deferred until the date the QOF is sold or December 31, 2026, whichever comes first, plus 15% of the deferred capital gain is cancelled.
- Held 10 + Years – Tax is owned on 85% of the deferred capital gain on December 31, 2026, since 15% of the deferred capital gain is cancelled. The added benefit for holding the QOF longer than 10 years is tax free proceeds on the sale of the QOF. If held the QOF is held until 2048, under the proposed rules, and the appreciation of the QOF will have tax-free proceeds when it is sold.
Example:
A taxpayer sells his business in 2018 and realizes a $1 million gain. The taxpayer formed a partnership as a QOF. The partnership holds QOZ business property.
- If the taxpayer sold the QOF in 2023 (Year 5), the taxpayer would pay $180,000 in tax on the deferred gain on April 15, 2024. The taxpayer would have saved $20,000 (10% of the original capital gain tax due of $200,000) in tax and deferred paying $180,000 for five years.
- If the taxpayer sold the QOF in 2025, (Year 7), the taxpayer would pay $170,000 in tax on the deferred gain on April 15, 2026. The taxpayer would have saved $30,000 (15% of the original capital gain tax due of $200,000) in tax and deferred paying $170,000 for seven years.
- If the taxpayer sold the QOF in 2028, (Year 10), the taxpayer would pay $170,000 in tax on the deferred gain on April 15, 2027. The taxpayer would have saved $30,000 (15% of the original capital gain tax due of $200,000) in tax and deferred paying $170,000 for eight years. Additionally, if the QOF had appreciated and was now worth $1.5 million, the taxpayer’s gain on the sale of the QOF would be completely eliminated. He would have a $500,000 gain, all tax free.
Investing in a Qualified Opportunity Funds
QOFs are new. There are many details (see below for a few) that need to be analyzed and considered before making a decision. A QOF provides a tool for taxpayers to sell appreciating assets and defer and reduce the amount of capital gain tax. It also allows them to invest in a qualified business or asset long term that, if it appreciates, could have potential tax-free returns.
Structuring a QOF can take time and will need careful planning.
Contact us to help you navigate through the details and options to see if a Qualified Opportunity Zone Investment is right for you.
Requirement Examples
A capital gain investment needs to be rolled into a Qualified Opportunity Fund (QOF) within 180 days of the sale. The partnership or corporation must have at least 90% of its assets in a QOZ and must use Form 8996 to certify that it is organized to invest in QOZ property.
Designated QOZs
The list of the designated QOZ’s can be found in the Federal Register at Federal IRB Notice 2018-48.
https://www.irs.gov/pub/irs-drop/n-18-48.pdf
Interactive Map California QOZs
https://cafinance.maps.arcgis.com/apps/webappviewer/index.html?id=d068b90cb97f4b429f3b180593036b7e
Michael J. Kouyoumdjian, CPA
Managing Shareholder
RP&B CPAs
This report is for information purposes only and is not a recommendation for any particular security. Mention of individual securities should not imply that we own the security or have owned it in the past. In addition, the information provided here should not form the basis for investment decisions. Past performance is no guarantee of future results. This information should not be used in any transaction without the advice and guidance of your Tax Professional. LifeSteps Financial has not independently verified, or attested to the accuracy or authenticity of the information, including any investment performance measurement.
