Overview
If you are facing tax payments as a result of capital gains, investing in a Qualified Opportunity Zone Fund may be worth exploring. By investing in this program you are given an opportunity to defer and potentially reduce tax on recognized capital gains, while achieving high returns by investing in real estate.
A Qualified Opportunity Zone Fund is any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property that holds at least 90 percent of its assets in qualified opportunity zone property. Similar to other investments, income may be paid on this investment. Cash flow may occur once the property improvements are complete and the property is leased or sold to third parties.
How does this program work?
Once you receive a reported capital gain from a flow-through entity, such as a partnership, S- corporation, or a trust/estate, you have 180 days from the end of the calendar year to make an investment in a Qualified Opportunity Zone Fund, regardless of how early in the calendar year the entity itself realized its gain. For example, if a partnership entity realized a capital gain in March, each partner’s 180-day triggering date will be December 31 of the same year and each partner will have until approximately June 28 of the following year to make their Qualified Opportunity Zone investment.
The Opportunity Zone program allows for the sale of any appreciated assets, such as stock, with a reinvestment of the gain into an Opportunity Zone Fund. There is no requirement to invest in a like-kind property to defer the gain. The fund then invests in Qualified Opportunity Zone Property.
Qualified Opportunity Zone Property
Qualified Opportunity Zone Property is used to refer to property that is qualified opportunity zone stock, a qualified opportunity zone partnership interest or a qualified opportunity zone business property, used in a trade or business conducted in a Qualified Opportunity Zone or ownership interest in an entity (stock and partnership interests) operating with such tangible property.
Conceptually, the Opportunity Zone Fund must bring property new to the entity to be used in the Opportunity Zone. A fund that simply acquires property already being used in the zone must make substantial improvement to the property. Substantial improvement requires improvements equal to the Opportunity Zone Fund’s initial investment into the existing property over a 30-month period.
Tax deferral through 2026
You may elect to defer the tax on some or all of a capital gain if, during the 180 day period beginning at the date of sale/exchange, they invest in a qualified opportunity fund. Any taxable gain invested in an Opportunity Zone Fund is not recognized until December 31, 2026, (due with the filing of the 2026 return in 2027) or until the interest in the fund is sold or exchanged, whichever occurs first. In addition, the deferred gain can be further reduced as described below.
Step up in tax basis of 10% of deferred gains
Gains deferred through an Opportunity Zone Fund receive a 10% step-up in tax basis after five years. Note that to take advantage of the 10% step-up in tax basis, you must invest by December 31, 2021. When the tax is triggered at the end of 2026, you will have held the investment in the fund for five years, thereby qualifying for the 10% increase in tax basis.
No tax on appreciation
Remaining in the qualified opportunity fund for at least ten years results in the cost basis of the property being equal to the fair market value on the date of sale/exchange (potential to lower cost basis but does not eliminate the gain recognition event on 12/31/2026).
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