• CogentCrusader

Opportunity Zones - A New Tax Deferral Strategy

Updated: Jan 24



Americans are passionate about taxes. We have reason to be. In recent years, Americans have spent more on taxes than on food, clothing, and housing combined (1). The Tax Foundation estimates Americans will pay $3.4 trillion to the federal government and $1.8 trillion to state and local governments in 2019 (2).


If you believe you’re paying too much tax, selecting investment vehicles that emphasize tax-advantaged opportunities could help reduce the amount of taxes you owe. One way is through an Opportunity Zone investment.


What are Opportunity Zones?

Qualified Opportunity Zones (QOZ’s) were created in the Tax Cuts and Jobs Act of 2017 to spur economic development in economically distressed areas like inner cities and rural communities. They are selected by a state’s Governor and certified by the US Department of Treasury. Investments into QOZ’s must be made into investment funds called Qualified Opportunity Funds. These funds must invest at least 90% of their assets into QOZ property, such as commercial real estate, housing, infrastructure and start-up businesses (3).


Potential Tax Benefits

For QOZ investors there are a trio of potential tax benefits regarding capital gains (4). To qualify for these tax benefits, you must invest capital gains into a QOZ fund within 180-days and make a deferral election via IRS form 8949 when filing your tax return.


First, let’s define the term Capital Gains. They are generally defined as the difference between what you paid for an asset (stocks, business, real estate, art, etc.) and what you have sold it for, assuming there is a profit. It is not straightforward - always consult your tax advisor to calculate your capital gains.


QOZ fund investors can defer taxes on capital gains until the earlier of when you sell the fund or December 31, 2026. This allows you time to plan for paying taxes on those capital gains. Additionally, if you hold the fund for at least 5-years prior to December 31, 2026, you’ll receive a 10% reduction of your capital gains tax liability. This is a nice little perk but not the main potential tax benefit.


The main potential tax benefit is the elimination of capital gains taxes on the QOZ fund itself when you hold it for at least 10-years (5). For example, if you make a proper deferral election of $100k into a QOZ fund and it grows to $150k after 10-years, you will not owe capital gains taxes on the $50k your investment earned.


Risks

These investments are not for everyone, though. There are many potential risks and pitfalls. They are illiquid, involve a high degree of risk, tax laws may change and there is no guarantee these investments will make money. Be sure to consult your tax, legal and investment advisors before considering a QOZ fund investment. This article does not constitute a recommendation for any particular investment.



Sources:

1 https://www.politifact.com/truth-o-meter/statements/2014/apr/23/tax-foundation/do-americans-pay-more-taxes-food-clothing-and-hous/

2 https://taxfoundation.org/publications/tax-freedom-day/

3 https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

4 Pursuant to Internal Revenue Code Sections 1400Z-1 and 1400Z-2.

5 Assumes investor is a resident of a state that conforms with the QOZ Program.

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