As part of the Tax Cuts and Jobs Act of 2017 Congress was attempting to balance out perceived and real inequities faced by many Americans. One hope was to provide incentives for investing in economically distressed communities.
If it sounds like an IRS trap for high-net-worth investors, I wouldn’t blame you for being suspicious, given Congress’ approval rating of late. But it’s actually proven to be a unique, nearly perfect storm of cooperation between government and private investment, leading to greater acceptance of the strategy due to reduced fear of triggering IRS audits. Something all stakeholders can agree on.
Qualified Opportunity Zone Investment Defined
Opportunity Zones (OZ) are low-income census tracts that have been nominated by their state governments and certified by the Treasury Department. Qualified Opportunity Funds are the vehicles the government allows investment to flow through from investors. America’s opportunity zone funds stand poised to receive a huge influx of dollars, given the enormous tax incentives that the Tax Cuts and Jobs Act of 2017 legislation has created.
The Case for Opportunity Zone Investment Funds
There are three major tax advantages to using Opportunity Zones as an investment:
- Deferment of capital gains until December 31, 2026.
- A step-up in basis of up to 10% on the original gain.
- Complete elimination of capital gains accrued in the opportunity zone fund after a 10-year holding period.
While deferment and step-up in basis are great features by themselves, the main reason investors are gravitating toward opportunity zone funds is for the reward of the tax-free gain if held for 10 years.
Opportunity Zone Investment Funds vs. 1031 Exchange Rollovers
1031s are tried and true strategies for real estate capital gains tax protection. But they have their limitations.
1031s are for real estate like-kind exchanges. OZ funds allow the same tax benefits for any type of asset investment gains, including stocks, bonds, etc.
1031s must include dollar for dollar principal and capital gain exchange. OZ funds have no restrictions on amount of capital gains to be invested.
1031s require a 45-day identification period. OZ funds have 180-day window of investment.
1031 funds can be deferred indefinitely, but all gains still must be paid eventually. OZ funds have an exit strategy with no tax on the growth of the investment if held for 10 years.
With 1031s capital gains are reduced through a step-up in basis only upon death. OZ fund investors receive a 10% step up in year 2026.
Case Study
An investor realizes a capital gain on the sale of any type of asset(s) totaling $100,000 and invests it in a qualified opportunity zone fund within the 180-day period.
They will have to recognize the capital gain by end of 2026 and pay the tax in 2027 with a step up of 10% … therefore the capital gain is lowered to $90,000.
After holding the investment for a total of 10 years in which time they sell, the entire growth of the investment is now considered tax free. Typically, these investments are targeted for 12-20% annual returns. Of course, there is no guarantee of past performance.
In Closing
This is a great way to free up principal and invest elsewhere without having to pay tax until year 2027. In year 2026, when the capital gain is realized, this can be offset with capital gain losses.
In year 2026, you could invest some of the original principal in a natural gas investment and receive an 80% tax deduction and possibly eliminate all capital gains, and receive .5% to 3% per month of income for rest of your life. Of course there is no guarantee of past performance.
Opportunity Zones can also be found in Puerto Rico, San Jose, Jacksonville (shipyards-owned by Khan), Las Vegas and Colorado Springs.
Tax planning is not just about reducing taxes in the current year but also being able to access monies in the future in tax favorable manners. Want to learn more about opportunity zone fund investments, give me a call!
