Learning all about “Qualified Opportunity Zones” with Duncan Campbell, CPA – A Blog From Duncan Campbell, CPA
The 2017 Tax Cuts and Jobs Act created Qualified Opportunity Zones in order to spur investment in distressed communities throughout the country. New investments in these Opportunity Zones through Opportunity Funds can receive preferential tax treatment. For most of the year we have been waiting for the State Governors to submit nominations for areas in their State to the US Treasury for approval. Finally, the areas in Texas and throughout the country have been designated and these investments are starting to gain momentum.
Investing these Opportunity Funds can provide three tax incentives:
1. Deferral of current Capital Gain(s)
2. Reduction of amount of gain realized through a basis adjustment if held for certain period of years, and
3. Permanent exclusion of gain on the appreciation of the property if held for 10 years.
What is an Opportunity Zone:
There are defined as low income community that meets certain poverty or median family income levels as defined by the IRS. The Governor of each State has to nominate these Zones for consideration by the US Treasury, and the US Treasury will approve the Zone as eligible for this opportunity. A complete list of the approved Zones can be found here: https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx. A quick search of the list shows that there are 628 designated zones in Texas alone.
What is an Opportunity Fund:
A partnership, a corporation, or an LLC that invests in at least 90% of its assets in Qualified Opportunity Zone Property. These Funds can be self-created, or 3rd Party Funds run by independent managers. Twice a year the Fund must meet this 90% standard to continue to be an Opportunity Fund, so fluctuations in the asset mix is allowed throughout the year.
Favorable Tax Treatment:
An investor can realize a gain from a sale or exchange of a capital asset and have 180 days from the date of disposition to reinvest the gain amount with a cash investment into an Opportunity Fund. If the investment is made within the 180 days than the original gain is deferred. Essentially it is like doing a 1031 exchange but in this case, you are using capital gain property to invest in Opportunity Zone property. In order to fully realize the benefits of the Opportunity Fund investment a 10-year hold is best. Here is how it works:
* Year 1 – Capital Gain realized and gain is invested in Opportunity Fund, 100% of the gain is deferred
* Year 5 – Tax basis increase in the Opportunity Fund of 10% of the original deferred gain.
* Year 7 – Another tax basis increase of 5% of the original deferred gain.
* December 31, 2026 – Taxable recognition of the original deferred gain less any 10% & 5% basis adjustments.
* Year 10 – Tax basis stepped up tax free to FMV of property.
To better illustrate what this means, here is an example:
Stock is sold for $100,000 gain in 2018 and within 180 days is invested in Opportunity Fund. Assume at end of year 10, FMV of Fund property is $1,000,000
* Year 1 – 2018 – Taxable Gain $0, deferred gain $100,000.
* Year 5 – 2022 – Basis in Fund increases by $10,000
* Year 7 – 2024 – Basis in Fund increases by $5,000
* Year 9 – 2026 – 2018 Deferred gain is realized, less basis adjustments, $85,000 taxable gain. Basis in Fund is now $100,000
* Year 10 – 2027 – Tax basis stepped up to $1,000,000 in Fund Investment. The $900,000 gain is completely eliminated.