Tax Benefit #: Permanent Exclusion
The third tax benefit that investors can enjoy is a permanent exclusion from taxable income on capital gains from the sale or exchange of an investment in an Opportunity Fund. Assuming the initial investment is held for at least 10 years. Its important to note that this exclusion only applies to gains accrued after an investment has been made in a Qualified Opportunity Zone.
Tax Deferral And Savings
A Qualified Opportunity Fund investment provides potential tax savings in three ways:
Tax deferral through 2026 – A taxpayer may elect to defer the tax on some or all of a capital gain if, during the 180-day period beginning at the date of sale/exchange, they invest in a Qualified Opportunity Fund. Any taxable gain invested in a Qualified Opportunity Fund is not recognized until December 31, 2026 , or until the interest in the fund is sold or exchanged, whichever occurs first. In addition, the deferred gain can be further reduced as described below.
Step-up in tax basis of 10% or up to 15% of deferred gains – A taxpayer who defers gains through a Qualified Opportunity Fund investment receives a 10% step-up in tax basis after five years and an additional 5% step-up after seven years. Note that to take full advantage of the 15% step-up in tax basis, the taxpayer must have invested by December 31, 2019. When the tax is triggered at the end of 2026, the taxpayer will have held the investment in the fund for seven years, thereby qualifying for the 15% increase in tax basis.
No tax on appreciation – Remaining in the Qualified Opportunity Fund for at least 10 years results in the cost basis of the property being equal to the fair market value on the date of sale/exchange.
How Investing In Opportunity Zones Works
The designation of Opportunity Zones is designed to help spur development of identified communities. In exchange for investing in Opportunity Zones, investors can access capital gains tax incentives available exclusively through the Opportunity Zone program. To access these tax benefits, investors must invest in Opportunity Zones specifically through Opportunity Funds. A qualified Opportunity Fund is a US partnership or corporation that intends to invest at least 90% of its holdings in one or more qualified Opportunity Zones. As previously mentioned, Opportunity Funds are governed by IRC section 1400Z-2 and Opportunity Funds can self-certify to the IRS. But each Opportunity Fund is responsible for ensuring that they abide by the guidelines of the Opportunity Program in order to be able to offer tax incentives.
Because the Opportunity Zone program is intended to stimulate positive growth within designated communities, there are restrictions on the types of investments in which an Opportunity Fund can invest. These investments are called Qualified Opportunity Zone property, which is defined as any one of the following:
- Partnership interests in businesses that operate in a qualified Opportunity Zone.
- Stock ownership in businesses that conduct most or all of their operations within a qualified Opportunity Zone.
- Property such as real estate located within a qualified Opportunity Zone.
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How Are Opportunity Zones Created
Low-income communities, as well as certain neighboring areas, are defined by population census tracts and can qualify as an opportunity zone. State governors nominate a limited number of eligible tracts for official designation. The certification and designation of an opportunity zone comes from the secretary of the treasury via their delegation of authority to the Internal Revenue Service . Detailed information on the eligibility criteria for census tract designation and the nomination and designation process can be found on the IRS website.
How Do Opportunity Zones Work Who Can Claim The Incentives And What Projects Can They Support
The Tax Cuts and Jobs Act included a new federal incentiveOpportunity Zonesmeant to spur investment in undercapitalized communities. Any corporation or individual with capital gains can qualify. The program provides three tax benefits for investing unrealized capital gains in Opportunity Zones:
- Temporary deferral of taxes on previously earned capital gains. Investors can place existing assets with accumulated capital gains into Opportunity Funds. Those existing capital gains are not taxed until the end of 2026 or when the asset is disposed of.
- Basis step-up of previously earned capital gains invested. For capital gains placed in Opportunity Funds for at least 5 years, investors basis on the original investment increases by 10 percent. If invested for at least 7 years, investors basis on the original investment increases by 15 percent.
- Permanent exclusion of taxable income on new gains. For investments held for at least 10 years, investors pay no taxes on any capital gains produced through their investment in Opportunity Funds .
Investors can take advantage of one or more of the benefits.
Apart from a few sin businesses, Opportunity Funds can finance a broad variety of activities and projects. Funds can finance commercial and industrial real estate, housing, infrastructure, and existing or start-up businesses. For real estate projects to qualify for Opportunity Fund financing, the investment must result in the properties being substantially improved.
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How Pwc Can Help
PwC can provide a complete suite of tax, assurance, and advisory services related to all phases of an opportunity zone fund investment lifecycle. We help with identifying qualifying opportunity zone investments, assisting in structuring opportunity zone investments to accomplish the specific goals of investors , advising on the operation of the opportunity zone investments, and the investors eventual exit from the opportunity zone investment. Our offerings include:
- Identifying avenues for taxpayers to utilize the Opportunity Zone Program
- Identifying various Opportunity Zone Fund structures for consideration and assisting with the implementation of the selected structure
- Confirming that an investment in an Opportunity Zone Fund qualifies for the benefits of the program
- Determining if state and local tax benefits may also be available
- Ongoing tax consulting and compliance related to the status of the Opportunity Zone Fund and its tax operations
- Assisting in the disposition of Opportunity Zone Fund qualifying properties and interests in Opportunity Zone Funds
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.
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What Is A Qualified Opportunity Zone Fund
In order for investors to reap the tax advantages associated with an opportunity zone, they must allocate capital through a qualified opportunity zone fund. A qualified opportunity zone fund is simply an investment vehicle designed to invest in assets within an opportunity zone.
Investors realizing capital gains can allocate these proceeds to a qualified opportunity zone fund, which will then purchase the real estate within the opportunity zone itself. As a rule, 90% of the assets these funds hold must be within the respective opportunity zone to qualify for tax advantages.
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.
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The Tax Benefits Of Opportunity Zones
- 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.
Facts About Opportunity Zones
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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Opportunity Zones Transparency Extension And Improvement Act
If enacted, the legislation would make the following changes to the program:
Extension of Deferral Period: In one of the titles that has garnered significant interest, the bill would extend the deferral period two years, to Dec. 31, 2028, and also lower the requirements for the additional 5 percent step-up basis by one year, from seven to six years. This is in part an effort to account for the Treasury Department’s two-year delay in issuing relevant final regulations, effectively delaying or discouraging certain investors from making Opportunity Zone investments and limiting the benefits that those investors could receive under the program. Under the bill, investors could continue to defer gains from investments in Qualified Opportunity Funds and provide the ability to meet the 10-year holding period, as Congress originally intended.
Allowing Qualified Opportunity Funds to Invest in Other Funds: Under current law, Qualified Opportunity Funds cannot invest in other Qualified Opportunity Funds, which limits the ability of larger investors to invest in smaller projects. Under the proposal, partnerships could elect to be organized as a “qualified feeder fund” and invest in smaller Qualified Opportunity Funds.
Tax Advantages Of Investing In 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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What Are The Tax Benefits Of An Opportunity Zone
Through an investment vehicle known as an Opportunity Fund, Opportunity Zones provide for both temporary and permanent tax deferral for eligible investors.
- Investment in an Opportunity Fund provides temporary deferral from other investments without immediately triggering recognition of those gains. The deferred gain must be recognized on the earlier of the date on which the EO investment is sold or Dec. 31, 2026.
- Opportunity Zones provide permanent deferral on capital gains if the opportunity fund is held for at least 10 years. The exclusion only applies to gains accrued AFTER an investor makes his/her investment in an Opportunity Fund.
- A qualified Opportunity Fund is a privately managed investment vehicle created as either a partnership or corporation for the purpose of investing in qualified opportunity zone property.
Which Option Is Best For You
How do you decide which option is right for you and your investment strategy? Answering this question is easier with the help of a trusted investment advisor, CPA, or financial consultant. However, to help you get started, consider following a few guidelines:
1031 Like-Kind Exchanges Are Most Suitable For:
- Active real estate investors. These investors should have the resources and / or expertise needed to maintain ongoing management.
- Investors who have already received a gain from a piece of sold real estate or other qualifying asset.
- Investors who do not need to access their principal capital.
- Older investors who plan on leaving any assets acquired through a 1031 Exchange as part of their will.
Opportunity Funds Are Most Suitable For:
- Passive investors who want to enjoy the benefits of professionally managed funds.
- Passive investors who are interested in diversifying their portfolios.
- Investors who have already received a gain from the sale of an asset, such as stocks, bonds, or real estate.
- Investors who want to have access to their invested principal.
- Investors who are planning on selling the investment within their lifetime.
Real estate can offer many unique benefits, including tax advantages. Working with a real estate expert can help you determine the type of real estate assets, and tax-deferred vehicle you should use to maximize your investment opportunities.
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Which Communities Are Zones And What Are Their Attributes
Twelve percent of US census tracts are Opportunity Zones . Governors of the 50 states and 4 territories and the mayor of Washington, DC, nominated the zones, which were officially designated by the US Department of the Treasury. The statute contains no provision to change which communities are classified as Opportunity Zones.
Urban Institute research finds that the designated zones have lower incomes, higher poverty rates, and higher unemployment rates than eligible nondesignated tracts. However, analysis shows minimal targeting of the program toward disinvested communities.
Urban ranked Opportunity Zone investment on a 1 to 10 scale, standardized across eligible tracts state by state, with 10 being the highest score. Just under one-third of Opportunity Zones are located in the three tracts that have the least investment, while 28 percent are in the three tracts attracting the most investment. This pattern is roughly similar to nondesignated tracts, with only very slight targeting toward lower-investment areas .
Opportunity Zones seem better targeted when measured by socioeconomic standards. Designated tracts have lower incomes, more poverty, and higher unemployment than eligible nondesignated tracts. Home values, rents, and homeownership rates also are lower. The designated tracts are less white and more Hispanic and black. Ages are similar while education levels are somewhat lower. The mix of urban and rural Opportunity Zones closely tracks community patterns .
Tax Benefit #: Temporary Capital Gains Tax Deferral
The first tax benefit that investors can enjoy is a temporary deferral of inclusion in taxable income. This deferral is only applicable for capital gains that are reinvested in an Opportunity Fund. Additionally, the deferred gain must be recognized before the opportunity zone investment expires or before December 31, 2026.
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How Does This Program Work
To defer a capital gain , a taxpayer has 180 days from the date of the sale or exchange of appreciated property to invest the realized capital gain dollars into a Qualified Opportunity Fund. The fund then invests in Qualified Opportunity Zone property.
The taxpayer may invest the return of principal as well as the recognized capital gain, but only the portion of the investment attributable to the capital gain will be eligible for the exemption from tax on further appreciation of the Opportunity Zone investment, as explained below. The Opportunity Zone program allows for the sale of any appreciated assets, such as stocks, with a reinvestment of the gain into a Qualified Opportunity Fund. There is no requirement to invest in a like-kind property to defer the gain.
Note that a taxpayer who receives a reported capital gain from a flow-through entity, such as a partnership, an S-corporation, or a trust/estate, has 180 days from the end of the calendar year to make an investment in a Qualified Opportunity Fund, regardless of how early in the calendar year the entity itself realized its gain. For example, if a partnership entity realized a capital gain in March, each partners 180-day triggering date will be December 31 of the same year and each partner will have until approximately June 28 of the following year to make their Qualified Opportunity Zone investment.
Additional Evidence Also Points To Lack Of Impact
The new study builds off prior research that finds minimal to no impact resulting from opportunity zone designation. Taken as a whole, research to date suggests that opportunity zone tax breaks have largely benefited areas already experiencing development, projects that would have occurred in the absence of an incentive, and/or projectssuch as self-storage facilities and bitcoin mining facilitiesthat do little to create employment and economic activity in surrounding communities. Notably, the evidence includes: