Here’s a new way to defer, reduce and even eliminate your capital gains.

I thought it would be interesting to share so I wrote this short summary.

As part of the 2017 Tax Cuts and Jobs Act (“TCJA”), Congress created the Qualified Opportunity Zones (“QOZ”) program to encourage development in economically distressed communities across the country which have been designated as Opportunity Zones by the various state and federal authorities.

To encourage private investment, the Treasury, acting through the IRS, provides potentially huge tax breaks for investors who invest in Opportunity Zones through a Qualified Opportunity Fund (“Opportunity Fund”).

An Opportunity Fund is a partnership or corporation organized for the purpose of investing in a Qualified Opportunity Zone business or real estate development.

The biggest carrot offered to investors is the chance to defer taxes on recent or potential capital gains from appreciated assets, such as real estate or stocks, until December 31, 2026.

By investing in an Opportunity Fund, an investor can:

• Defer taxes on the original capital gain until the end of 2026.
• Reduce up to 15% of the tax bill on the original capital gains if they remain invested in the Fund for at least seven years.
• Completely eliminate the tax on any appreciation (new capital gains) on the original investment after the 10-year mark in the Opportunity Fund.

The QOZ program is designed to encourage long-term investments. The longer an investor leaves their capital gains in an Opportunity Fund, the greater the tax savings.

Here is a summary of the long-term benefits.

Here’s an example of the benefits an investor would reap by reinvesting in an Opportunity Fund using $10 million of capital gains from a recent sale of real estate.

Year 1:  In 2019, if the investor reinvests the entire amount of capital gains in an Opportunity Fund within 180 days of the sale, none of the sale proceeds are taxable in 2019.

At the highest current capital gains rate of 20%, they would get to keep $2 million that would have been paid as tax otherwise. Assuming even a conservative rate of return on that $2 million, that’s bonus money that would not have been possible without the QOZ program.  

Years 5 – 7:  If the investor cashes out of the Opportunity Fund during this time frame, they will be given a 10% discount on the original capital gains of $10 million. In other words, the investor would only pay taxes on $9 million.

Years 7 – 10:  After seven years, the investor is given an additional 5% forgiveness of the original capital gains for a total 15% discount.

The investor would only be responsible for the tax on $8.5 million of the original $10 million amount. At a capital gains rate of 20%, that’s a savings of $300,000 for merely holding the investment for at least seven years.

After Year 10:  If the taxpayer cashes out of the Opportunity Fund after ten years for $15 million ($5 million gain), that $5 million in appreciation is tax-free and only $8.5 million of the original capital gains amount of $10 million. That’s a total of only $1.7 million in taxes on the $15 million gain for an effective tax rate of 11.33%.

The Qualified Opportunity Zones program is a tremendous opportunity for investors sitting on capital gains to reinvest those gains in an Opportunity Fund to reap significant tax benefits and potential profits while investing for a social cause.

They would be helping economic development in the neediest neighborhoods across the country by developing businesses and real estate in those communities and, in turn, providing valuable jobs for eager residents.

It’s a true win-win for everyone involved.

Investing for growth,

Michael Foley