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Opportunity Zone Tax Benefit Example

The Benefits Of Opportunity Zones

Opportunity Zones: Will Tax Breaks for Investors Benefit Communities Too?

Opportunity Zones and Qualified Opportunity Funds can be a fit if you expect to or have already realized a big capital gain. Because you are allowed to defer all of the capital gains taxes on that already-realized gain within a 180-day period, and because you can eliminate some taxes entirely , you have the freedom to realize those gains without immediate tax concerns.

The Typical Tradeoffs of Opportunity Zones

Limited Liquidity. The tax benefits of Opportunity Zones can be significant, but only for investors who are willing to wait at minimum 5 years and in many cases at least 10 years. Money has to stay in a QOF for at least five years from the fund close, not the date you invest in the fund, to realize the tax reduction benefits and ten years from the fund close to realize the basis adjustment benefit. In almost every case QOFs do not allow withdrawals during that initial 5-year period and may have limited withdrawals until the fund has hit its 10-year mark, so access to funds is limited.

Costs. Qualified Opportunity Fund costs and fees can be substantially higher than the costs and fees associated with more traditional investments which can eat up a substantial amount of the benefits. Set-up costs for QOFs, for example, can run above 6% of capital invested, and annual management fees typically range from 1.50% to 2.00% plus 15%-20% of returns above a specified return .

Benefits Of Investing In Opportunity Zones

Opportunity Zones offer tax benefits to investors who elect to temporarily defer tax on capital gains if they timely invest those gain amounts in a Qualified Opportunity Fund . Investors can defer tax on the invested gain amounts until there is an event that reduces or terminates the qualifying investment in the QOF , or December 31, 2026, whichever is earlier.

The length of time the taxpayer holds the QOF investment determines the tax benefits they receive.

  • If the investor holds the QOF investment for at least five years, the basis of the QOF investment increases to 10% of the deferred gain.
  • If the investor holds the QOF investment for at least seven years, the basis of the QOF investment increases to 15% of the deferred gain.
  • If the investor holds the investment in the QOF for at least 10 years, the investor is eligible to elect to adjust the basis of the QOF investment to its fair market value on the date that the QOF investment is sold or exchanged.

Chapter : What Are Qualified Opportunity Funds

A Qualified Opportunity Fund is any investment vehicle organized as a partnership or corporation for the purpose of investing in at least one Qualified Opportunity Zone. A Qualified Opportunity Fund must hold at least 90 percent of its assets in Qualified Opportunity Zone Property. Learn how to invest.

In the appendix to this guide, several examples demonstrate the tax savings potential of investing in Opportunity Zones, and the resulting impact on investment returns.

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How To Invest In Qualified Opportunity Funds

Establishing a QOF is not a simple task. For that reason, most investors choose to take advantage of the Opportunity Zone tax incentives by placing their qualified capital gains into an existing QOF investments run by an institution. Like any professionally managed fund, these QOFs manage the underlying investments with the goal of generating returns for their investors.

Where Are Opportunity Zones Located

Opportunity Zones In New York State and City

There are 8,764 opportunity zones in the U.S., which represent 12% of all census tracts. Many of the regions designated as opportunity zones have suffered from a lack of investment for decades and can be found on an interactive map shown on the U.S Department of Housing and Urban Development website. Just over 23% of opportunity zones are in rural areas.

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Qualified Opportunity Zones: What Investors Should Know

Key takeaways:

  • The 2017 Tax Cuts and Jobs Act established the Qualified Opportunity Zone program to provide a tax incentive for private, long-term investment in economically distressed communities.
  • Investors in these programs are given an opportunity to defer and potentially reduce tax on recognized capital gains.
  • Tax savings are only available when investors retain the investment in the Qualified Opportunity Fund for the time frame stated.

What this may mean for you:

  • If you are facing a significant tax liability as a result of capital gains, investing in a Qualified Opportunity Fund may be worth exploring, provided you invest within a prescribed amount of time.

How To Invest In Qualified Opportunity Zone Funds

Anyone with capital gains may invest in Opportunity Zone Funds. In practice, most Qualified Opportunity Funds that are raising money from outside investors have filed for an SEC exemption under Regulation D, Rule 506 or 506. As such, they have limited their offerings to accredited investors only. With some exceptions, an accredited investor is an individual with annual income of at least $200,000 over the last two years, or net worth exceeding $1 million .

Investment minimums in most Qualified Opportunity Funds that are seeking outside investment are often in the 5- or 6-figure dollar range. Typical investment minimums can range from $25,000 to $100,000, with some funds requiring a minimum investment of $250,000, or even $1 million.

Hundreds of such funds exist, with varying investment strategies. A list of Opportunity Zone funds is available on OpportunityDb.com. In general, Qualified Opportunity Funds are private placement funds that do not trade publicly on an exchange. While hundreds of funds are available directly to accredited investors, many funds are available only through wirehouse or RIA platforms. And many thousands more are self-funded or privately held funds that are not seeking capital from outside investors.

Disclosure: The author of this guide has ownership in OZPros.com.

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How Opportunity Zone Tax Benefits Work

Deferral of capital gains taxes. If investors move any realized capital gains into a qualified Opportunity Zone Fund within 180 days of the asset sale, they can defer paying capital gains taxes on that gain until December 31, 2026 or until they sell their Opportunity Zone Fund investment, whichever is earlier.

Potential reduction of deferred capital gains tax liability. Not only can Opportunity Zone investors defer their capital gains taxes, but they may also be able to minimize, or even eliminate, those taxes under certain circumstances.

  • If an investor holds their Opportunity Zone Fund investment for at least 5 years prior to December 31, 2026, they can reduce their deferred capital gains tax liability by 10% through a step-up in basis.
  • If an investor holds their Opportunity Zone Fund investment for 7 years prior to December 31, 2026, they can reduce their deferred capital gains liability by another 5%.
  • If an investor moved their capital gains into a qualified Opportunity Zone Fund in 2019 and held that investment for 10 years total, they could pay zero dollars in capital gains taxes on any appreciation from their original Opportunity Zone Fund investment. That is because Opportunity Zone Fund gains earned from Opportunity Zone investments can qualify for a step-up in basis at year 10.

The tax benefit sunsets on December 31, 2047 to allow for an investment beyond 10 years if an investor so chooses.

Tax Advantages Of Investing In Opportunity Zones

Who gets the tax benefits of ‘opportunity zones?

The primary tax benefit for investors of qualified opportunity funds is that they can defer tax payments on capital gains realized from prior investments. More specifically, if an investor allocates capital gains from a prior investment into a qualified opportunity fund within 180 days from the sale date, then that person is eligible to defer tax payment on the gain until the opportunity fund is sold or Dec. 31, 2026, whichever comes first.

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New Research Adds To Evidence That Opportunity Zone Tax Breaks Are Costly And Ineffective

Policymakers should enact commonsense reforms to opportunity zones to boost transparency and accountability, stem rising costs, and focus attention on communities most in need.

Important new research by economists Patrick Kennedy and Harrison Wheeler adds to a growing volume of evidence that opportunity zone tax breaks, created as part of the 2017 Tax Cuts and Jobs Act , are costly and poorly targeted and do little to create jobs or improve conditions in poor communities. Instead, opportunity zones provide massive tax benefits to wealthy investors while subsidizing investment in few communities with relatively higher incomes, home values, and educational attainment as well as stronger income and population growth.

A growing body of evidence bolsters the case for commonsense reforms that would improve the transparency and accountability of zone incentives, such as instituting reporting requirements and requiring assets used to qualify for tax breaks to be used exclusively within a zone. Absent future evidence to the contrary, opportunity zone incentives should not be extended beyond their scheduled 2026 expiration.

The 3 types of opportunity zone tax breaks

Opportunity zones provide three different tax breaks for investors that roll over gains earned outside a zone into special funds called qualified opportunity funds:

  • Investors can defer payment of taxes on gains earned outside a zone if those gains are then invested in an opportunity fund.
  • The Ultimate Guide To Investing In Opportunity Zones

    The Opportunity Zone policy initiative is the biggest economic development program in U.S. history and the tax incentive of a lifetime. This guide provides comprehensive information on how Opportunity Zones have the power to catalyze positive social impact, and how you can reap massive tax savings by investing in Qualified Opportunity Funds.

    Looking for a quicker guide?

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    What Are The Tax Benefits Of Investing In Opportunity Zones

    Before we dive into the main tax benefits of investing in qualified opportunity zone property, its important to note that there are some caveats of these tax breaks, including:

    • The tax benefits of opportunity zones only apply to capital gains tax: Some investment properties may produce ordinary income . And typically, any ordinary income generated through an investment in an opportunity zone or opportunity fund will be taxed by the IRS at the taxpayers normal tax rate.

    MoneyTermQualified opportunity fund

    A qualified opportunity fund , often referred to as just an opportunity fund, is an investment vehicle like a partnership or corporation organized for investing in opportunity zone properties.

    • They require a one-to-one purchase and development spend: To take advantage of the tax benefits of a qualified opportunity zone investment, youll have to match the purchase price of the properties in renovations. That is, youll have to invest as much in developing the properties as you spent in purchasing them. When you meet that threshold, youll be eligible to receive the tax benefits.

    Opportunity zones provide three main tax benefits for investors: tax deferral, step-up in basis and tax-free status after 10 years.

    Facts About Opportunity Zones

    Opportunity zone program offers social determinants of health ...

    The Tax Cuts and Jobs Act included changes for businesses and individuals. One of these is the creation of the Opportunity Zones tax incentive, an economic development tool that allows people to invest in distressed areas. This incentive’s purpose is to spur economic development and job creation in distressed communities by providing tax benefits to investors. Low income communities and certain contiguous communities qualify as Opportunity Zones if a state, the District of Columbia or a U.S. territory nominated them for that designation and the U.S. Treasury certified that nomination. Following the nomination process, 8,764 communities in all 50 states, the District of Columbia and five U.S. territories were certified as Qualified Opportunity Zones . Congress later designated each low-income community in Puerto Rico as a QOZ effective Dec. 22, 2017. The list of each QOZ can be found in IRS Notices 2018-48 and 2019-42. There’s also a visual map of the census tracts designated as QOZs.

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    Where Are Opportunity Zones Located And How Are They Created

    Opportunity zones are dispersed throughout the country and represent 11% of all U.S. census tracts. Spread throughout a mix of urban, industrial, suburban and rural areas, opportunities zones are home to over 30 million people. You can view an interactive map of qualifying opportunity zones on the U.S Department of Housing and Urban Development website.

    Individual states, in collaboration with local governments, were able to nominate a specific geographic area for the Qualified Opportunity Zone program through March 21, 2018. These areas were required to meet certain low-income requirements, among other criteria. The actual certification as an opportunity zone comes from the IRS.

    Qualified Opportunity Fund Example

    One example of a qualified opportunity fund is the Woodforest CEI-Boulos Opportunity Fund, a collaboration between Woodforest National Bank and CEI-Boulos Capital Management LLC. The fund’s investments include $2 million to redevelop a historic hotel in Selma, Alabama. In a press release, Congresswoman Terri Sowell noted: “This critically important investment will not only revitalize a historic asset of downtown Selma, but also support the city’s growing civil rights tourism industry.”The fund has also made investments in affordable housing. In Indianapolis, the fund contributed $3 million to a housing project that’s part of the city’s redevelopment plan.

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    How To Invest In An Opportunity Zone

    Investors in a free market can allocate capital to any asset class, geographic region, or sector that they choose. With that said, factors such as tax incentives, demographics, seasonality, ethical ideology, and growth prospects often play a key role when it comes to narrowing down investment choices.

    To incentivize investment in low-income communities, the federal government created qualified opportunity zones and a host of tax benefits available for those who invest in them via a qualified opportunity fund. For those unfamiliar, a qualified opportunity fund is an investment vehicle, such as a corporation or a partnership, that is organized for the purpose of investing in assets within qualified opportunity zones.

    For a corporation or partnership to become a qualified opportunity fund it must self-certify by annually filing Form 8996 with its federal income tax. Once designated, qualified opportunity funds must invest at least 90% of their assets in designated opportunity zones to be eligible for tax benefits.

    The Tax Benefits Of Opportunity Zones

    Unlocking opportunities with Opportunity Zones

    KEY TAKEAWAYS

    • Opportunity zones are a new tax benefit, established by the Tax Cuts and Jobs Act of 2017, designed to spur investment in economically distressed communities.
    • The tax benefits are two-fold: taxes owed on capital gains can be deferred, and in some cases reduced, if the gains are reinvested in an opportunity zone fund and the gains on opportunity zone investments held at least 10 years are tax free.
    • Investments in an opportunity zone are subject to many rules and restrictions, most of which are in two sets of proposed Treasury Department regulations.

    Opportunity zones are a tax benefit created by the Tax Cuts and Jobs Act of 2017 to spur investment in economically distressed communities. In exchange for qualified investments in specific places, a taxpayer may defer and reduce taxes owed on capital gains and earn tax-free capital gains for opportunity zone investments held at least 10 years.

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    The New Research Fills An Important Data Gap In Understanding Opportunity Zones Impacts

    Despite their cost and scope, opportunity zones lack even the most minimal reporting requirements. To shed light on their impact, the new research from Kennedy and Wheeler, based on preliminary tax return data for 2019 and 2020, uses multiple data sources to provide important insights into programs initial impact. The reports four key findings show that:

  • Opportunity zone investment is extraordinarily concentrated in a relatively few zones, with nearly two-thirds63 percentof opportunity zone census tracts covered by the initial data receiving zero capital. Just 1 percent of tracts received 42 percent of the invested capital, and the top 5 percent received 78 percent of total investment. The New York City area received the largest volume of opportunity zone investment, at $3.8 billionmore than twice the amount received by the Los Angeles area, which ranked second at $1.7 billion.
  • Opportunity zone investment is overwhelmingly concentrated in real estate, construction, and finance. Real estate alone received more than half of opportunity zone dollars. By contrast, only 1 percent of the firms that received opportunity zone funds were in manufacturing. Rather than directly investing in property or business assets, the vast major of opportunity zone investments were structured as partnerships to allow investors to claim the special deduction for pass-through entities that was also created by the 2017 TCJA.
  • Tax Treatment Of Qof Investments

    An investor can receive up to three tax benefits by reinvesting capital gains in a QOF. The first is temporary tax deferral on any capital gains reinvested in a QOF within 180 days of realization. Tax payment is deferred until the investment is sold or exchanged, or until December 31st, 2026, whichever comes first.

    The second benefit is a 10 percent step-up in basis for capital gains reinvested in a QOF if the investment is held for five years. The basis is increased an additional 5 percent for any investments held for seven years. This step-up in basis means taxpayers can exclude up to 15 percent of the value of their reinvested capital gains from their taxable income, decreasing the investors tax liability when they sell or can no longer defer taxation.

    Finally, QOF investors can permanently exclude from taxation any capital gains that accrue after their investment in a QOF, if the investment is held for at least 10 years. Opportunity zones increase the basis of any investment held in a QOF for 10 years to 100 percent of its fair market value on the date it is sold or exchanged.

    Table 3 shows that any gain accrued after the $1.5 million investment in the QOF is exempt from taxation if it is held for 10 years or longer. Assuming the investor made another $500,000 over the decade of the QOF investment, the investor would save an additional $119,000 in taxes.

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