As 2021 comes to a close, so does another important opportunity zone deadline.
Investors who are looking to take advantage of the benefits of investing in a qualified opportunity zone fund (QOF) have until December 31, 2021 to place their cash relating to a capital gain into a QOF to receive the 10% benefit on their initial deferred gain.
Not sure what this means? Take a quick look below for an overview of opportunity zones.
What are opportunity zones?
Generally, opportunity zones are low-income census tracts, or areas adjoining low-income census tracts. In 2018, over 8,700 zones were nominated by the governor of each state, district or U.S. territory and then certified by the Treasury. Covering 12% of all U.S. territory, every major metropolitan area has at least one opportunity zone, and there are many located throughout rural areas as well.
Why do tax benefits exist for opportunity zones?
Tax benefits related to opportunity zones were part of the Tax Cuts and Jobs Act of 2017. The goal was to incentivize people who were sitting on large unrealized capital gains to invest in these low-income census areas by providing three different benefits, highlighted below.
What are the opportunity zones tax benefits?
If you invest a capital gain appropriately in a qualified opportunity fund (QOF), you can benefit in three primary ways:
- Tax deferral: You elect to defer the capital gain you invest until the earlier of December 31, 2026 or whenever you sell your qualified fund investment.
- Step-up benefits: If you invest long-term, you get a step-up in the capital gain you are deferring. If you hold the investment for five years, you get a 10% step-up. Note that this expires after December 31, 2021.
- No capital gain tax on appreciation: If you hold the QOF investment for 10 years or more, when you sell that QOF investment, you will not have to pay tax on the capital gain on any appreciation that has occurred from the initial time of the investment. So if you invest $1 million dollars today in a QOF and the investment is worth $3 million 10 years from now, then the $2 million increase is basically tax free.
It is important to note that you cannot get the permanent of exclusion from tax on an OZ investment unless you have the initial capital gain tax deferral.
What do I need to invest in a QOF?
To invest in a QOF, you must have capital gain from an actual or deemed sale or exchange of property, or any other gain included in the calculation of capital gain for federal income tax purposes; the sale must be with an unrelated third party; and you must invest within 180 days of the transaction triggering the gain as the general rule. The gain can be from personal, business or investment property.
There are additional and more complex rules surrounding the 180-day investment period depending upon how and where the gain originates. We recommend reaching out to a CPA to determine your own 180-day period.
Why is this important now?
The last step-up benefit of opportunity zones will end after December 31, 2021. While you will still be able to make a qualified investment after that date, you will no longer get the 10% step up on the gain.
For example, if you have a $100,000 gain that you invest by the end of 2021, on your 2026 tax return you will only pay tax on $90,000. However, if you invest afterward, you will pay tax on the full $100,000 on your 2026 tax return.
While this may seem like a reason to rush an investment, we highly encourage people to spend the time to ensure the fund they are placing the cash into is a good investment first.
Wipfli can help. Our opportunity zone specialists provide advice to investors about asset and income testing, auditing, compliance and other topics and questions. We help investors figure out which gains could qualify for a deferral by the end of this year. We also help validate by reviewing offering agreements and PPMs to make sure the correct opportunity zone language is included.
Click here to learn more.
Sign up to receive additional tax and opportunity zone information in your inbox, or continue reading on:
Tax savings strategies when tax law is a moving target
IRS releases extended guidance on qualified opportunity fund relief
How You Can Benefit From Investing in Opportunity Zones
Why you still need estate planning even if you don’t have a taxable estate