Opportunity Zones might help you defer Capital Gains taxes, but read the fine print!
You have probably heard about Opportunity Zones: Opportunity Zone Investments allow the investor with a capital gain to defer and reduce their tax liability. The longer you hold the investment the better the tax consequences. Investing in Opportunity Zones does not eliminate your gain- it reduces and defers.
Opportunity Zones were added into the tax code in late 2017. Opportunity Zones consist of 8,700 census-designated “economically challenged” communities, where new investments are eligible for tax benefits to incentivize investment.
You don’t need to live, work or have a business in an Opportunity Zone to to invest; however one must invest – through a Qualified Opportunity Fund (QOF) – into an income producing entity (like investment real estate) that is located within the Opportunity Zone. Examples of QOFs include the Virtua 506(c) Opportunity Zone Funds as well as the Caliber Investment Fund.
How do you Invest in a QOF?
With established funds (like the two referenced above) the steps are minimal. However, if you are looking to invest in a specific property within an opportunity zone, say a 50 Unit apartment building, you have to jump through a few more hoops.
In order to take advantage of an Opportunity Zone, without investing in a specific fund, you will need to form a corporation or partnership by filing the appropriate forms with the Secretary of State. Once an entity is established, it must be self-certified by filing IRS form 8996 with your federal income tax return. Then annually, you will report that the QOF meets the investment standards designated by the tax code. Once the QOF is established, you can invest funds – equal to a recent capital gain – into a property within an Opportunity Zone. The capital gain is not restricted to real estate; the capital gain can be from the sale of stocks. Investments must 1. be a minimum of $50,000, 2. are limited to equity investments in businesses and real estate and 3. are subject to substantial rehabilitation requirements. Rehabilitation requirements state that – in the first 30 months – you must invest additional capital equal to or greater than 100 % of the initial adjusted basis of the property. So, in other words, you can’t just buy an apartment building, collect the rent and call it good. You have to substantially invest in the property and increase the assessed value significantly.
So What is the Bottom Line? Reduce and Defer.
Opportunity Zones reduce your tax liability and Opportunity Zones defer your gain. The longer you stay in the investment, the better your savings. To illustrate: assume you have a capital gain of $100, and you reinvest into an opportunity fund. How long you hold the investment determines the net effect:
If you hold the Investment 5 years, you can reduce the original capital gain by 10%, so when the opportunity fund is dissolved, your original $100 gain is essentially $90. So your taxes associated with the original capital gain are reduced. Any appreciation in the opportunity fund is still taxed as a normal.
If you hold the Investment 7 years, you can reduce the original capital gain by 15%, so when the opportunity fund is dissolved, your original $100 gain is essentially $85. So your taxes associated with the original capital gain are reduced. Any appreciation in the opportunity fund is still taxed as a normal.
If you hold the Investment 10 years, you can reduce the original capital gain by 20%, so when the opportunity fund is dissolved, your original $100 gain is essentially $80. So your taxes associated with the original capital gain are reduced. Here’s the the kicker: when you hold the investment for 10 years: any appreciation in the opportunity fund is TAX FREE.
What’s Government Got to Do with it?
Local and state governments are gearing up for harvesting this tool and utilizing it to its full capacity. Governor Newsom’s recently released 2019-2020 state budget proposes utilizing synergies between QOF and Enhanced Financing Districts to aid California’s housing crisis. Sacramento city officials intend to leverage city resources, including tax revenue, to aid projects. Sacramento officials are hosting a free forum February 1st to discuss investments and implementation issues. Click here for more information including registration and thde agenda.
Want to take advantage of Opportunity Funds?
If you are interested in investing in Properties within an Opportunity Zone, Bacon Commercial can help. We have access to all properties in Opportunity Zones- anywhere -and locally we are in a position to unearth off-market investments as well. Call us at (916) 761-1202.