One segment of the Tax Cuts and Jobs Act that has garnered the attention of the business community, especially real estate professionals, is the creation of Qualified Opportunity Zones. Investment in these zones pose a significant tax incentive to investors who roll their capital gains into low income communities designated as “Qualified Opportunity Zones.” This incentive was established as an innovative solution to provide more economic activities in these low income communities. The Qualified Opportunity Zones are attractive to investors due to the potential of gain deferral and tax abatement in combination with economic revitalization of distressed communities across the nation.
While an Opportunity Fund appears similar to a like kind exchange (1031 exchange), it differs in that it not only provides gain deferral but potential permanent gain reduction as well. This new fund provides three tax incentives to potential investors:
- Deferral of gain;
- Potential reduction of the gain if property is held for 5 years; and
- Potential permanent exclusion of gain on the appreciation in a Qualified Fund if the property is held over 10 years.
To help understand the tax incentives from a Qualified Opportunity Zone, please see below for an example:
John sells property resulting in a capital gain of $100. John rolls the $100 gain into a Qualified Opportunity (QO) Fund within 180 days. John does not need to recognize gain on his $100 the year that he sold his initial investment.
– If John holds the Qualified Opportunity Fund for 5 years, his basis in the original gain steps up from zero to 10% (or $10). This effectively reduces John’s future gain by 10% or $10.
– If John holds the Qualified Opportunity Fund for 7 years, his basis in the original gain steps up to 15% (or $15) resulting in a reduction of his future gain by $15.
– Gain on the original deferral will have to be recognized when the property is sold or December 31, 2026, whichever is sooner. If John is still holding the QO fund on December 31, 2026, he will have to recognize gain on his original $100 gain less any basis step-up he has received.
– The potential permanent exclusion of gain from the appreciation of the QO Fund can occur when John holds the Qualified Opportunity Fund for 10 years or more, sells the QO Fund, and makes a special election. If those requirements are met, he will not pay any capital gain on the appreciation of his $100 investment in the QO Fund upon the sale.
As you can see, the Qualified Opportunity Zone has the ability to produce significant tax savings while infusing funds into low-income communities. We are still pending guidance from the Treasury on this new legislation. If you would like more information on this topic please give us a call at 210.733.6611 or email us at office@atkgcpa.com.
Keeping it real as always,
