The Tax Benefits of Investing in Opportunity Zones
Learn why opportunity zones continue may be an attractive option to some investors thanks to government tax incentives
The Tax Cuts and Jobs Act of 2017 (TCJA) brought many changes to the tax law, including changes to the standard deduction and tax brackets.
Another big change was the creation of tax incentives for investments in qualified opportunity zones, which, according to the IRS, are meant to encourage economic development and create jobs within “distressed” communities. Significant tax benefits can be had by investors who decide to invest capital into these opportunity zones.
This is a first-of-its-kind investment opportunity that has the potential to benefit both struggling communities and investors alike, through investing in some areas that carry a risk for commercial real estate projects.
So, what are opportunity Zones and Qualified Opportunity Funds, and what are the tax benefits of investing in them?
The definition of an opportunity zone
The creation of these zones is essentially an economic development tool from the government that’s meant to help develop low-income areas in urban, suburban, and rural areas of the U.S. In order for a location to qualify as an opportunity zone, it must be nominated by the state and must be certified by the Secretary of the U.S. Treasury. A Qualified Opportunity Fund is one that is created to invest in a qualified opportunity zone property and files a tax return that is either a partnership or corporation.
There are now opportunity zones within all 50 U.S. states, as well as the District of Columbia and five of the U.S. territories, according to the IRS. There are 8,700 opportunity zones in total.
The tax benefits of opportunity zone investment
Tax benefits are offered to investors in opportunity zones to encourage this new avenue of funding developing communities. Investors can defer tax on their qualified capital gains from their investments in a Qualified Opportunity Fund until the earlier of either the date when the investment is sold or exchanged or December 31, 2026.
If the investment is held in the fund for more than five years, there is a 10 percent exclusion of the deferred gain, and 15 percent if it’s held for more than seven years. If it’s held for at least 10 years, investors are then eligible for an increase in the basis of the investment equal to the fair market value on the date that the investment is sold or exchanged. Investors don’t have to live or run a business within an opportunity zone in order to take advantage of the tax benefits.
Because the opportunity zones are part of a 10-year program that is accretive in nature, investors should act soon to see the biggest advantages of these investments. The biggest returns will be seen by those who invested in the first year of the program.
To summarize, the tax benefits of opportunity zone investments are:
- The deferral of capital gains reinvested in an opportunity fund
- The step-up in basis when investments are held for five or seven years
- A permanent exclusion of capital gains from taxable income if the investment is held for at least 10 years (on gains accrued after investment in an opportunity fund)
According to the Economic Innovation Group (EIG), the potential for this program to help communities is $6.1 trillion of unrealized capital gains. This number comes from an EIG analysis of the Federal Reserve Survey of Consumer Finances and Financial Accounts, which found that U.S. households alone were “sitting on” over $2 trillion in unrealized capital gains in stocks and funds at the end of 2015, and $3.8 trillion at the end of 2017. Add that number to unrealized capital gains of U.S. corporations ($2.3 trillion) and the total potential capital eligible for reinvestment in opportunity zones is $6.1 trillion.
Even if these numbers aren’t fully realized in the program, it’s clear that this program is both a huge step for community development as well as a community investment. Nevertheless, it has unique risks in terms of commercial real estate. Location, location, location is, of course, the mantra of real estate investing, and some of the distressed communities have significant challenges that spur the need for these incentives in the first place. Nevertheless, the right project may reap significant tax breaks that significantly reduce this risk and create the potential for significant rewards.
At Provident CPA & Business Advisors, our priority is helping you pay the least amount of tax legally possible. We’ll help you get total control over your tax expenses and provide you with proactive, safe, and proven ways to lower income taxes. Contact us today to learn more about our tax minimization and growth and profit improvement services.