The Tax Cuts and Jobs Act of 2017 contained a unique benefit for taxpayers (particularly those that incur capital gains) and certain communities. The legislation established the Opportunity Zone program—an innovative way to promote long-term private sector investment in economically distressed communities nationwide.
What are Opportunity Zones?
Opportunity Zones are low-income areas that the Treasury has designated as “qualified opportunity zones” (QO Zone). These QO Zones were created to provide significant tax incentives for taxpayers to invest realized capital gains into “Qualified Opportunity Funds” (QO Funds) which in turn make investments in certain property and businesses located or operated within the designated QO Zones.
What are the incentives?
There are three incentives that a taxpayer can elect to take advantage of:
- Temporary deferral of capital gain
- Exclusion on deferred capital gain up to 15 percent
- Permanent exclusion of gain on appreciation if held for 10 years
What can this mean for you?
If you, as a taxpayer, incur a $50,000 realized capital gain from the sale or exchange of property such as a stock (either in the stock market or a private holding) or real estate investment, you can invest all or part of that gain (not the gross proceeds) into a QO Fund. The Fund will in turn invest in property in a QO Zone, and you can delay capital gains tax on the amount invested until December 31, 2026. You would also be eligible to exclude 15% of the gain if funds are invested in the QO Fund for seven years. Perhaps the best part, however, is that future appreciation of the investment is completely free of tax if held within the QO Fund for ten or more years.
If we return to that initial $50,000 investment of realized capital gain into a QO Fund, we can find big benefits. Let’s say you held it there for 10 years, and the investment value appreciated to $150,000. After the seventh year you would be required to pay tax on 85% of the original $50,000 gain, resulting in a permanent exclusion of $7,500. At the end of the tenth year, you can sell the interest in the QOZ Fund, and incur a capital gain of $100,000 which would be completely exempt from capital gains tax, assuming all conditions were met. That’s a win for the taxpayer, and likely a win for the community.
How can you get started?
To take advantage, a QO Fund must be set up as the investment vehicle as either a corporation or partnership. At least 90% of the QO Fund’s total assets should consist of QOZ Property, of which there are the three types:
- Stock: Can be in a corporation if it is a “qualified opportunity zone business” (QOZ Business)
- Partnership interest: Any capital or profits interest in a partnership if the QO Fund acquired the interest or the partnership was a QOZ Business
- Business property: Tangible property of a QO Fund or QOZ Business that is used by a trade or business operating in a QO Zone
A QOZ Business is any trade or business in which substantially all of the tangible property owned or leased by the taxpayer is QOZ Business Property. “Substantially all” is defined as 70 percent or more of tangible property. At least 50% of the total gross income must be from active conduct of such trade or business activity. Several types of businesses are ineligible, including liquor stores, tanning salons and country clubs. For any property in the QO Zone that did not begin with the QOZ Fund or QOZ Business, the QOZ Fund or QOZ Business must substantially improve the property.
Even though the rules related to Opportunity Zone investing are complicated, the tax benefits can be significant. However, it is critical to understand the criteria for qualification, therefore we very much recommend professional consultation before making a contribution to QOZ Fund.
Tom Cooney and Crystal Faulkner are partners with MCM CPAs & Advisors, a CPA and advisory firm offering expert guidance and beyond the bottom line thinking for today’s public and private businesses large and small, not-for-profits, governmental entities and individuals. For additional information, call 513-768-6796 or visit www.mcmcpa.com. You can listen to Tom and Crystal daily on WMKV and WLHS on BusinessWise, a morning and afternoon radio show that profiles highly successful people, companies, organizations and issues throughout our region.