What Are The Tax Benefits Of Opportunity Zones

How Long Should You Hold Your Investment In A Qualified Opportunity Zone

Investors who want to defer taxes on capital gains can receive tax benefits from opportunity zones if they meet specific time requirements for investing the realized gain in a qualified opportunity fund . As a result, investors can postpone paying taxes on realized capital gains until December 31, 2026 .

For the gains to be 100% tax-free, the investment in a QOF needs to be held for 10 years. The combination of tax deferral and tax-free investing can provide a significant advantage to QOF investments versus other traditional investments that are taxed on investment gains. A good adviser should be able to provide a side-by-side comparison for an investor of paying taxes on capital gains today versus deferring them and investing in a QOF with tax-free growth.

Lorenzo Gonzalez And Sean Speer Outline How Economic Growth And Dynamism Have Not Been Evenly Distributed Across The Province Especially When Rural And Urban Areas Are Compared

SUMMARY OF RECOMMENDATIONS

1) Pursue intergovernmental cooperation with the federal government on launching the Opportunity Zones model in Ontario or across the country.

2) Enact a made-in-Ontario place-based investment tax credit that draws on a combination of the Opportunity Zones model, the federal governments Atlantic Investment Tax Credit, and Ontarios 2002 Tax Incentives Zones Act.

3) Redesign the Northern Ontario Heritage Fund and the Rural Economic Development Fund to better target private investment in economically-distressed communities.

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:

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Who Can Benefit From The Opportunity Zone Act

• Any taxpayer desiring to invest capital gain in order to obtain tax deferral and potential tax-free returns.
• A company or business already located or planning to locate in an opportunity zone that is looking for equity investment.
• Syndicators or sponsors looking to create funds for themselves and others to invest.
• Any party that owns real estate in an opportunity zone and is looking for an opportunity a marketing advantage and/or to cash out.

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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Estate Planning With Qofs

If a QOF is gifted to a charity or an individual other than the taxpayer’s spouse, this gift would be considered an inclusion event and may trigger the inclusion of the deferred capital gains in the taxpayer’s taxable income in the year the gift is made. If a QOF is gifted to a grantor trust or distributed to a taxpayers beneficiaries upon death, it should not be considered an inclusion event. (For more information on grantor trusts, please see Trusts and Taxes: Exploring the Federal Income Tax Implications of Trust Strategies.

Further, if a QOF is gifted to a grantor trust or distributed upon death prior to December 31, 2026, there will be no step-up in cost basis in the QOF. Although there is no step-up in cost basis, the taxpayer’s holding period in the QOF will tack on or carry over to the beneficiary of the QOF. However, this may present an income tax issue for the beneficiary if the beneficiary does not hold sufficient liquid assets to cover the impending deferred capital gains tax liability associated with the QOF.

Example 5In April 2020, Tiffany’s cost basis in the QOF is considered to be zero even though she contributed $5 million. In 2021, Tiffany dies and leaves her interest in the QOF to Diana, her 25-year-old daughter.

If a QOF owner intends to distribute a QOF upon death, the owner may want to consider providing additional funds to the recipient to cover the potential income tax liability.

Tax Benefits Of Investing In An Opportunity Zone

Opportunity Zones can be a way to defer capital gains taxes on recently realized capital gains .

Investors who have eligible realized capital gains can roll those gains into a QOZ fund. If they do so within 180 days of realizing the gain, three forms of tax incentive are available:

Tax Deferral. First, capital gains rolled into a QOF may be deferred until the investment is sold or exchanged, or the end of 2026 , whichever is sooner. If the investor puts $1 million of capital gains into a QOF in a timely fashion, for example, that gain will not be taxed right away. If the investors capital gain tax rate were, say, 35%, that would mean an additional $350,000 that is reinvested and compounding for them. .

Basis Adjustment. In addition, the investor can save even more through an adjustment in cost basis. If the investor holds the qualified investment for at least 10 years, the investor is eligible for an adjustment in the basis of the investment in the QOF. At this milestone, the investment in the QOF would have its cost basis adjusted to match the fair market value on the date that the QOF investment is sold or exchanged.

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Potential Flaws Of Opportunity Zones Loom As Do Risks Of Large

The 2017 tax law created a new tax break to encourage investment in low-income areas but, as high-profile Wall Street, Silicon Valley, and real estate investors rush to profit from it, critics are raising sensible concerns about the policy:

The tax break includes no requirements to ensure that local residents benefit from investments receiving it.

For these reasons, the tax break risks exacerbating the three main flaws of the 2017 tax law itself: it mainly benefits wealthy investors instead of workers and residents of distressed communities, reduces federal revenues and makes our long-term fiscal challenges worse, and creates new opportunities for tax avoidance.

Congress hastily drafted and passed the 2017 law without public hearings or broad expert input, and the new tax break for opportunity zones was among the provisions that didnt receive nearly the attention they deserved. The President and Congress should take the time now to consider how to ensure that the benefits of this new tax break go to those who need them most, rather than creating mini tax havens for the wealthy. In its upcoming rulemaking, Treasury should focus on limiting investors ability to use opportunity zones to avoid taxes without undertaking any activity that could potentially benefit distressed communities and their residents.

Why Gao Did This Study

Congress created OZ to spur investments in distressed communities. According to Census Bureau data, about 10 percent of Americans live in the nearly 9,000 Zones. Taxpayers who invest in Qualified Opportunity Fundsthat in turn invest in Zoneshave the potential to receive significant tax-related benefits on their qualified investments. GAO was asked to review OZ implementation.

This report describes key features of OZ and how it compares to other federal tax expenditures aimed at spurring investment in low-income and distressed areas, and evaluates the executive branch’s ability to effectively evaluate OZ’s performance. GAO compared OZ’s key features with those of three other community development tax expenditures, analyzed executive branch documentation, and interviewed agency officials about plans to collect data and report on performance.

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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 has the potential to be 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. Thus, to be eligible for the 10% step-up in tax basis, the taxpayer needed to invest by December 31, 2021 and invest by December 31, 2019 for the additional 5% step-up in tax basis. If the taxpayer will have held the investment in the fund for seven years at the end of 2026, the taxpayer would qualify for the 15% increase in tax basis. Due to the rule regarding recognition of gain no later than December 31, 2026, the step-up in tax basis benefit is no longer available for new investors beginning with the 2022 tax year.

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 fundâs investments include $2 million to redevelop a historic hotel in Selma, Alabama. In a press release, Congresswoman Terri Sowell noted: âThis critically important investment will not only revitalize a historic asset of downtown Selma, but also support the cityâs growing civil rights tourism industry.âThe fund has also made investments in affordable housing. In Indianapolis, the fund contributed $3 million to a housing project thatâs part of the cityâs redevelopment plan.

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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.

A Side By Side Comparison

To further understand the differences between Opportunity Zones and a 1031 Exchange, weve conducted a side by side comparison looking at the following factors: rollover, qualified assets, investment structure, capital gains tax referral, capital gains tax reduction, and capital gains on final sale.

1031 Like-Kind Exchange

• Rollover. An investor must identify replacement property within 45 days. The investor must reinvest both the principal and capital gains within 180 days of sale. This transaction can only be conducted via a qualified intermediary.
• Qualified Assets. The 1031 Exchange can only be completed between like-kind property.
• Investment Structure. The 1031 Exchange is typically used for single asset swaps. However, you can exchange one property for more than two properties and vice versa so long as the new properties are like your original property.
• Capital Gains Tax Referral. Capital gains tax payments for the initial investment may be deferred indefinitely. However, if the property is sold, then you will have to pay capital gains taxes.
• Capital Gains Tax Reduction. No capital gains reduction is available with the exception of a step up in basis upon death of the property owner.
• Capital Gains Tax On Final Sale. An investor will have to pay capital gains tax on the final sale of the property.

Opportunity Fund Investment

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On Your 2026 Tax Return You Report The Capital Gains Tax On The Original Asset You Sold

And since, by now, you have held the Opportunity Zone investment for over five years, you also can claim the 10% tax reduction on the taxable amount of your original capital gain.

Example, continued: In April 2027, you pay a capital gains tax on $180,000 from the sale of the Apple stock several years ago.

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.

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Offsetting The Step Down Of The Itc

In an ideal world, I believe the zones will be utilized and they will help offset some of the step down in the Investment Tax Credit , Spano added.

The ITC is a 30% tax credit for solar systems on residential and commercial properties, and steps down to 26% in 2020, 22% in 2021, and in 2022, 10% for commercial and utility-scale projects and zero for solar.

The final benefit of the Qualified Opportunity Zones program is if the investor holds the investment for more than 10 years, any subsequent gain recognized escapes federal tax entirely, said Petra. Overall, the tax benefits available to investors should translate to long-term, cheaper capital, he said.

To date, most of the qualifying transactions in the zones have been in real estate, said Petra. Generally, real estate projects are well suited but as folks have gotten more comfortable with the program, other industries have gained interest in the program.

Has your company been involved in solar developments in Opportunity Zones? Share your experience in the comment section below!

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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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What Defines An Opportunity Zone

There are nearly 9,000 opportunity zones in all 50 states, plus five U.S. territories, which are home to about 36 million people, or 12 percent of the population. The zones include urban, suburban, and rural areas. Basically, each zone must have a poverty rate of at least 20 percent or median family income of no more than 80 percent of the statewide income, in most cases.

How Are Opportunity Zones Working

Opportunity zones work by giving people and corporations a series of capital gains tax breaks for investing in opportunity funds, which then invest in zones, and holding those investments over time. … So far, opportunity zone investors appear to be focused on market-rate real estate such as luxury apartments and hotels.

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The Importance Of Consulting An Attorney

As business people, we look at the definition of opportunity zones in geographic areas and the qualification requirements of the business, he said. Because its not always easy to determine whether a business qualifies for the benefits, his company always consults attorneys. Our attorneys advise us about how to present our applications for qualification, he said.

The eligible tracts for the zones are based on economic indicators of median family income and poverty, said Petra. States are limited to establishing zones in 25% of their low-income communities. In other words, if a state has less than 100 tracts identified as low-income communities, 25 qualify, he explained. The tracts are chosen based on statistics from the U.S. Census.