To attract private investment in distressed communities throughout the U.S., Congress has created a generous tax deferral program that allows investors to rollover their capital gains into special funds designated for investment in these areas. Depending on how long the money stays in the fund, taxpayers can earn permanent exclusions from gains for all or a portion of the new investment. This tax break was enacted as part of the Tax Cuts and Jobs Act (TCJA). Let’s explore how the new Opportunity Zone program works.
Special funds called “Qualified Opportunity Funds” are the investment vehicles authorized to make investments in designated Opportunity Zones. Contributing to these funds yields the tax benefit, and there is no limit on how much can be invested.
To participate, investors acquire interests in a partnership, corporation, or limited liability company that holds qualified opportunity zone property. Taxpayers also can self-certify by starting funds to finance commercial and industrial real estate, housing, infrastructure, and current or start-up businesses. Qualified entities must hold at least 90% of their assets in qualified zone property, and real property much be “substantially improved” to qualify as an Opportunity Fund project. To self-certify, a taxpayer completes a form, which will be released in the Summer of 2018, and attaches that form to the taxpayer’s federal income tax return for the taxable year.
Three Tax Benefits Possible
The Opportunity Zone provision allows three possible tax benefits:
- Investors can defer capital gains from the sale of any asset by rolling gains over into a Qualified Opportunity Fund.
- Investors get a step-up in basis on the deferred gain of either 10% or 15% depending on how long they continue their investment in the Fund.
- Investors can get a permanent exclusion from gain on the appreciation of their interest in the Fund if they hold the investment for 10 years.
Temporary Deferral: Investors who realize a capital gain can reinvest the money in a Qualified Opportunity Fund within 180 days from the date the capital asset was sold. If investors hold their interest in the fund for at least five years, they get a basis increase of 10% of the deferred gain they reinvested. If they stay in for seven years, they receive an additional 5% increase in basis. If the investor is still holding an interest on December 31, 2026, the investor will recognize gain on the deferred amount at that time, less the 15% increase in basis.
Rob, a real estate developer, joins an LLC, Advanced Homes, that qualifies as a Qualified Opportunity Fund. Rob sells unrelated stock and realizes $200,000 in capital gains. Within 180 days of the date Rob sold his stock, Rob invests $100,000 cash in Advanced Homes. This investment represents half of Rob’s stock gain. Rob does not have to report the $100,000 invested in the Opportunity Fund as income. If Rob holds his interest for five years, he will get a $10,000 basis increase. If he sells his Fund interest for $200,000, he will only recognize $190,000 of gain, as follows:
Sale price: $200,000
Rob’s deferred gain: $100,000
Rob’s basis increase: $10,000
Gain recognized: $190,000
Rob would get an additional $5,000 basis increase if he waits an additional 2 years before selling his interest in the Opportunity Fund. If he sold them for $200,000, he would have a basis of $15,000 in his interest and a gain recognized of $185,000.
Deferred Gain Recognized in 2026: If Rob holds the interest on December 31, 2026, he must recognize the balance of the deferred gain on that date. In the above example, that would be $85,000.
Permanent Exclusion: An additional benefit is if the investor keeps an interest in a Qualified Opportunity Fund for a total of 10 years. If so, the investor will receive a step-up in basis that results in no gain on the appreciation of the investor’s interest in the Fund. Thus, if he sold his interest for $300,000, he will not have to pay gain on the $215,000 that has never been taxed ($300,000 minus the $85,000 taxed on Dec. 31, 2026.)
Opportunity Zone Designation
Under TCJA, the states, D.C., and U.S. possessions nominate low-income communities to be designated as Qualified Opportunity Zones, which are eligible for the tax benefit. So far, the Treasury Department has designated Opportunity Zones in 18 States, including Georgia, Florida, Tennessee and Pennsylvania. Included in the most recent list are areas in 79 Georgia counties with 26 in Fulton, 15 in Muscogee, 14 in Bibb County, 13 in Richmond, and 12 in Dekalb. Note that you do not have to live in a state to donate to its opportunity zones. Qualified Opportunity Zones retain this designation for 10 years.
Get Started Now
The potential tax benefits from investing in Opportunity zones are significant but take some planning. In particular, taxpayers need to consider how long they may want to hold the investment because the benefits of this investment vehicle are tied to the five, seven, and 10-year holding periods. The key is to get educated now on this little-publicized tax break enacted as part of the TCJA.