Opportunity Zones have the potential to be one of the biggest tax incentives ever. However, we’ve found that not a lot of people are aware that they exist or how to take advantage of them. Before we get into a discussion about Opportunity Zones and the related tax benefits, ask yourself a few basic questions:
- Have you experienced a capital gain event in 2018 or expect to have one in 2019? Or perhaps you would be interested in harvesting a capital gain in order to take advantage of a tax minimization tool utilizing the Opportunity Zone’s capital gain deferral/elimination benefits.
- Would you like to defer paying taxes on that gain until 2026 in exchange for investing your capital gain money in a Qualified Opportunity Zone Fund (QOF)?
- When you pay the tax in 2026, would you also like only to pay tax on 85% of the capital gain in exchange for holding the QOF investment of the capital gain proceeds for seven years?
- One last question, would you like to forever defer the tax on the appreciation of the QOF investment?
If you answered yes to these questions, you should consider an investment in a QOF. There are a few more basic ground rules involved with this investment to consider:
- You have 180 days from the date of your capital gain event to invest money in a QOF. If your capital gain is coming from a flow-through interest in a Partnership or S corporation, you have the option of using either the end of the tax year or the actual date of the capital gain event.
- The QOF has until the earlier of six months or the end of the tax year to invest at least 90% of its money in Qualified Opportunity Zone Business Property (QOZBP). QOFs are self-certifying funds and can be set up as a partnership or corporation. The QOZBP can take the form of an investment in a Qualified Opportunity Zone Business (QOZB) such as a partnership or corporation, or the fund itself can hold the QOZB.
- QOZBs are businesses that derive at least 50% of its revenue from operations within a QOZ. QOZBs also have a requirement that at least 70% of their business property be QOZBP. QOZBP is a property that was;
(a) acquired after 12/31/2017;
(b) the original use of the property commences within the QOZ, and;
(c) substantially all of the use of the property happens within the QOZ.
Further, there is a requirement that the QOF or QOZB substantially improve the property. The QOF or QOZB has up to 30 months to invest enough in improving the property so that the cost of the property has doubled. For real estate investors, the substantial improvement requirement only relates to the purchase price of the building.
If you are still reading, you must be ready to hear about the tax breaks related to an investment in a QOZ. Tax incentives include:
- There will be a deferral of capital gain investment in a QOF until the earlier of the sale date of the QOF investment or December 31, 2026.
- Holding the QOF investment for five years will allow you to eliminate 10% of the capital gain. Holding the QOF investment for an additional two years will enable you to eliminate another 5% of the capital gain. Thus, you will never pay tax on a total of 15% of the invested capital gain if you hold the QOF investment for seven years.
- If you hold the QOF investment for ten years, you will not pay tax on the appreciation of the investment if you sell before 2047.
- Ohio is one of just a few states, at this point, to offer an additional incentive for investing in an OZ. Ohio’s proposed legislation provides for a 10% tax credit on investments in OH OZs of at least $250,000.
One last thing to keep in mind, while the tax breaks are significant, an investment of this type does not come without risk. While we’ve outlined some of the basics of investing, this is a very new and complex area of tax law, and there are still a lot of unknowns. Please contact either Cheryl Ganim or Jennifer Wesselman at Barnes Dennig if you have any questions.