Get in the zone: Investing in Qualified Opportunity Zones

January 17, 2019

qualified-opportunity-zones

The Tax Cuts and Jobs Act (TCJA) created a new opportunity for business owners and taxpayers with capital gains to shield taxes on those gains if the investment is made into a Qualified Opportunity Zone.

What is a Qualified Opportunity Zone?

A Qualified Opportunity Zone is an economically-distressed community nominated by each US State or Territory governor (and approved by the Secretary of the Treasury) where new investments may be eligible for favored tax treatment. Here’s a map of Opportunity Zones.

What is an Opportunity Fund?

An investment vehicle, usually a partnership or corporation— set up with investor funds which resulted from a capital gain— that invests in Qualified Opportunity Zone property.

What are the tax incentives for investing in an Opportunity Zone?

  • Ability to defer capital gains

  • Possible reduction in the amount of capital gains taxes

  • Possible exclusion of gain on the appreciation of the investment in a Qualified Opportunity Fund

How do I realize the full benefit of investing in the Opportunity Fund?

To capture the full benefit of this opportunity, sell a capital asset at a gain. Within 180 days, invest the proceeds (the entire amount) into an Opportunity Fund.

When you hold the investment in that fund for five years, you’ll realize a 10% reduction in gain from the original investment. If you hold the investment in that fund for an additional two years (seven years total), you’ll realize an additional 5% reduction in gain from the original investment.

There’s no monetary cap on the amount you can invest into an Opportunity Fund.

Is there a catch?

Of course!

If you sell your interest before the five year holding period, you pay capital gains taxes on 100% of the deferred gain, plus appreciation of the investment in the Opportunity Fund.

If you sell your interest after the five year holding period but before holding the investment for seven years, you pay capital gains taxes on 90% of the deferred gain plus appreciation of the investment in the Opportunity Fund.

If you’re holding the investment in the Opportunity Fund on Dec 31, 2026, you’ll need to pay the deferred tax on the original investment only.

Example

On December 3, 2018 Joe sells stock in Apple, Inc. and realizes a long-term capital gain of $100,000. On January 3, 2019, Joe invests his $100,000 into Smooth Move Real Estate Fund, LLC— a qualified opportunity fund. Assume a 15% long term capital gains rate.

Scenario 1: sell the interest after four years for $400,000

  • Recognize gain of $400,000

  • Capital gains tax at 15%= $60,000

  • Capital gains tax savings at 15%= $0

Scenario 2: sell the interest after six years for $650,000

  • Recognize gain of $90,000 on original investment

  • Recognize gain of $550,000 on appreciation of investment

  • Capital gains tax at 15%=  $90,000

  • Capital gains tax savings at 15%= $1,500 ($10,000*.15)

Scenario 3: sell the interest after seven years for $750,000

  • Recognize gain of $85,000 on original investment

  • Recognize gain of $650,000 on appreciation of investment

  • Capital gains tax at 15%= $112,500

  • Capital gains tax savings at 15%= $2,250 ($15,000*.15)

Scenario 4: hold the interest as of December 31, 2026

  • Recognize gain of $85,000 on original investment

  • Capital gains tax at 15%= $12,750

Scenario 5: sell the interest after ten years for $1,000,000

  • Recognize gain of $0 on original investment (because it was taxed in 2026)

  • Capital gains tax savings at 15%=$2,250

  • Recognize gain of $0 on appreciation of investment

  • Capital gains tax at 15%= $0

  • Capital gains tax savings at 15%=$135,000

Total capital gains tax saved: $137,250

How do I get in the zone? And should I?

To take advantage of this opportunity, you’ll have to invest in or start a Qualified Fund that would invest in Qualified Opportunity Zone Property.

If you have a capital asset that has appreciated in value and you want to divest yourself of that asset and invest those proceeds into another long-term asset that you’ll hold for a minimum of five years (and a max of ten), then you may want to invest in a qualified opportunity zone.

If you’re an investor that doesn’t want to hold an investment for at least five years, then this option may not be for you. At the very least, you should talk to your trusted advisor about this opportunity to determine if investing in a qualified opportunity zone is right for you.

Mark Puzdrak

CPA

Mark Puzdrak is a Certified Public Accountant (CPA) with more than 13 years of professional experience helping small to medium-sized businesses with their tax and accounting needs including individual, corporate, and partnership income tax returns along with business and individual tax planning. Mark is a member of the American Institute of Certified Public Accountants and the Texas Society of Certified Public Accountants. He is licensed as a Certified Public Accountant in Texas and Pennsylvania. He earned both of his bachelor of arts degrees in accounting and finance from Lycoming College in Williamsport, PA. Mark is committed to delivering tax and planning services that meet each client's unique objectives with a focus on services for small to medium-sized businesses as well as clients in the Real Estate, Manufacturing, Entertainment, and Professional Services industries. Mark lives in Austin, Texas with his wife, Kelly. He enjoys reading biographies, visiting small Texas towns, and the occasional scotch and cigar.
Read more articles from Mark Puzdrak

Guide to Business Borrowing

Learn what banks are looking for when they prepare to make loans. Our guide covers what business owners need to know when they prepare to borrow.

BBoT-COVER-GeneralBorrowing

Download eBook