What is an Opportunity Zone?
Opportunity Zones allow you to defer capital gains tax to 2026 by investing your capital gains in qualified OZ investments. If held for 10+ years, your OZ investment will be exempt from capital gains tax upon sale down the road. Opportunity Zones are widely believed to be the single greatest tax incentive ever granted by the US government. Here are the specifics:
What is an Opportunity Zone?
Opportunity Zones were created under the Tax Cuts and Jobs Act of 2017 (Public Law No 115-97). The purpose of an Opportunity Zone is to create a tax incentive for investors to direct their investments into distressed, low-income geographic areas. The desired result of the Opportunity Zones is economic growth and job creation in these distressed, low-income communities.
States nominated specific areas for the designation and the U.S. department of Treasury certifies that nomination. There are more than 8,760 designated Qualified Opportunity Zones located in all 50 States, the District of Columbia, and five United States territories.
What is the tax incentive for investors?
Tax Deferral through 2026 – A taxable gain invested in an Opportunity Zone is not recognized until December 31, 2026 assuming the interest in the fund is not sold or exchanged.
Step-up in Tax Basis of 10% of Deferred Capital Gains - In addition to the deferral, the taxpayer will benefit from a 10% step-up in the basis of capital gains if invested before December 31, 2021. To further illustrate this, if $500,000 of capital gains was invested into an Opportunity Zone Fund, $50,000 or 10% of the $500,000 would not be taxed come tax season in 2027.
Step-up in Basis of Appreciation – After 10 years, there will be an automatic step-up in basis to equal the fair market value of the asset, so that if the asset is sold there will be zero capital gains to report and zero tax to pay on the appreciation of the asset. The taxpayer will benefit also from the portion of the gain that would have been taxed as ordinary income tax rate otherwise known as depreciation recapture.
How much time do I have to invest?
A taxpayer has 180 days from the date of the sale or exchange of appreciated property to invest the realized capital gain (including section 1231 gains) into a Qualified Opportunity Fund. The Qualified Opportunity Zone rules allow for appreciated assets such as stock to be reinvested. Flow-through entities such as Partnerships and S-Corporations can also elect to defer the gain.
The rules are different for a taxpayer who receives a reported capital gain from a flow-through entity such as a partnership, S-Corporation, or trust/estate that was not deferred at the entity level. In such a case the taxpayer has 180 days from the end of the calendar or from the entity’s original tax deadline to make their Qualified Opportunity Zone Investment.