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Tax Planning

Opportunity Zone Investments Create Tax Deferral Planning

Have you realized gain from the sale of an asset and want to defer paying the tax?  Opportunity Zone Investments may be the solution for you. If you have a large taxable gain from the sale of a stock, asset, or business and who would like to defer that gain with the possibility of excluding some of it from taxation you should investigate Qualified Opportunity Funds (QOF). These funds are a new investment vehicle created as part of the 2017 Tax Cuts and Jobs Act.

To help communities that have not recovered from the Great Recession , the new tax law promotes investments in certain economically disadvantaged communities,  These areas are called Opportunity Zones.  Investments in a QOF provide unique tax incentives that was designed to encourage taxpayers to participate in these funds.

Reinvesting Gains

Starting in 2018,  taxpayers generating capital gains from the sale or exchange of non-QOF property to an unrelated party may elect to defer that gain. In order to receive the deferral the gain must be reinvested in a QOF within 180 days of the sale or exchange. Only one election is permitted  with respect to a particular sale or exchange. If less than the full amount of the gain is reinvested in the QOF, the remainder is taxable in the year of sale. The amount of the gain – not the amount of the sale’s proceeds, as is the case with a 1031 exchange – needs to be reinvested in order to defer the gain.

The gain will be deferred until the date the QOF investment is sold or December 31, 2026 – whichever is earlier. At that time, the taxpayer includes the lesser of the following as taxable income:

  • The deferred gain, or
  • The fair market value of the investment, as determined at the end of the deferral period, reduced by the taxpayer’s basis in the property.

A taxpayer holding a QOF for 10 years or more before selling it can elect to permanently exclude the gain from the sale that is in excess of the originally deferred gain (i.e., the appreciation).

Qualified Opportunity Fund Basis

The basis of a QOF that is purchased with a deferred gain is $0 unless either of the following increases applies:

  •  If the investment is held for 5 years, the QOF’s basis increases from $0 to 10% of the deferred gain.
  •  If the investment is held for 7 years, the QOF’s basis increases from $0 to 15% of the deferred gain.

Taxpayers holding a QOF at the end of 2016 that was purchased with deferred gains must include the original deferred gain as  income on that taxpayer’s 2026 return. The  basis of the investment will then be increased by the amount of the included gain.

If the QOF investment is held for at least 10 years before being sold, the taxpayer can elect to increase the basis to the property’s fair market value. This adjustment means that the QOF’s appreciation is not taxable when it is sold.

Illustration of Qualified Opportunity Funds Benefits

Example 1: On May 31, 2018, Stephanie sold a residential rental property for $4 million, resulting in a gain of $1 million. Within the 180-day window, she invested that $1 million into a QOF and elected the temporary gain deferral exclusion. On July 1, 2026, she then sold the QOF for $1.5 million. Because Stephanie held the investment for over 7 years, its basis is enhanced by $150,000 (15% of $1 million). Because the investment’s fair market value is greater than the original deferred gain, she must include a taxable gain of $1.35 million ($1.5 million – $150,000) in her 2026 tax return.

Example 2: The facts are the same as in Example 1, except Stephanie waited to sell the QOF until 2030, meaning that she held it for nearly 12 years. Because she had the investment on December 31, 2026, she was required to include $850,000 ($1 million – $150,000) of deferred gain on her 2026 return, and her basis in the QOF was increased from $0 to $850,000. After selling the QOF for $1.5 million, Stephanie elected to permanently exclude the gain by increasing her basis to $1.5 million (the fair market value on the date of the sale). Thus, the post-acquisition gain on the QOF occurring in 2030 will be excluded from income.

Mixed Investments – If a taxpayer’s investment in a QOF consists of both deferred gains and additional investment funds, it is treated as two investments; this provides the tax benefits of both types: the temporary gain deferral and the permanent gain exclusion (which applies only to the deferred gain).

Qualified Opportunity Funds

To defer gains-related taxes through the recently enacted opportunity zone investments program, taxpayers must invest in a QOF – an investment vehicle that is organized as a corporation or a partnership for the purpose of investing in properties within qualified opportunity zones. These investments cannot be in another QOF, and the properties must have been acquired after December 31, 2017. The fund must hold at least 90% of its assets in the qualified-opportunity-zone property, as determined by averaging the percentage held in the fund on the last days of the two 6-month periods of the fund’s tax year. Taxpayers may not invest directly in qualified opportunity zone property.

Partnerships – Because a QOF that is purchased with deferred capital gains has a basis of zero, taxpayers who invest in QOFs that are organized as partnerships may be limited to deducting the losses that these partnerships generate.

Designation of Opportunity Zone Investments

A low-income census tract can be specifically designated as a qualified opportunity zone after nomination from the governor of that community’s state or territory. Once the qualified opportunity zone nomination is received in writing, the treasury secretary can certify the community as a qualified opportunity zone. Once certified, zones retain this designation for 10 years.

The Department of the Treasury and the Internal Revenue Service will issue further details regarding this new incentive in the near future, including additional legal guidance and an outline of of the procedure for electing to defer a gain. This new provision creating Opportunity Zone Investments provides taxpayers with significant tax deferral and tax savings opportunities.

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