David Moore with Equity Advantage asks the expert attorney Connie Rathbone with Dunn Carney about Opportunity Zones. They look at the Opportunity Zone program’s primary benefits and the wow factor it provides for investors. Some of these benefits expire over the next few years. Learn how to take advantage of this investment option now.
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What Are the Benefits of an Opportunity Zone?
David Moore: What are the benefits or why would somebody consider an Opportunity Zone an opportunity?
Connie Rathbone: The benefits are all related to taxes. In this program, you only get the tax benefits if you invest capital gain. Let’s say you sell a piece of real property or you sell some stock. Let’s say your sales price is two million dollars, and your basis is one million dollars. You can put the one million dollar basis in your pocket and invest the other one million in a qualified opportunity fund. With that one million dollars, you will get three different tax benefits. The first two are really nice, but they’re not particularly compelling. The third benefit is the wow moment, and when I get there, I’d like for you to say wow.
David Moore: We like the wow moments.
Connie Rathbone: We like the wow moment. Okay, so the first benefit is, if you sell a capital asset and you have a capital gain, normally you would pay tax on that capital gain at the end of the year of the sale. You can defer that tax until December 31, 2026. Okay, so that’s the tax deferral, that’s the first benefit.
The second benefit is that if you hold the property for five years, you can get a 10 percent step up in basis on that property.
David Moore: That’s nice.
Connie Rathbone: If you hold it for seven years, you get another 5 percent. So if you invest by the end of 2019, you can get a 15 percent step up in basis. Taking our same million-dollar investment, that means on December 31, 2026, you only have to pay tax on $850,000 at the capital gain rate in place at the time of that, in 2026. So that’s the second benefit.
Now the wow moment is that if you wait 10 years to sell, all of the gain and appreciation that occurs from the time you invest until you sell, the capital gain is waived. In other words, you get a full step up in basis, and there is no tax on the gain or appreciation during the hold period. Whether that hold period is 10 years or up to 30 years.
Now remember that one of the elements of the Opportunity Zone program is that you have to substantially improve the property. So if you’re doing a good job, you substantially improve the property, and it will cost you, let’s say a million dollars to substantially improve it. Well if it’s going to cost you a million dollars, hopefully that’s worth a million five, meaning you’ve got some appreciation there. Then let’s say we have some more good years, so at the end of ten years it’s appreciated another million dollars.
So now you have a million in it, but you have a property worth $2.5 million. There is no tax on that additional $1.5 million gain.
David Moore: That is a wow because we got a 15 percent bump in the basis of the initial-
Connie Rathbone: Correct.
David Moore: Gain coming into it, but then everything gained, all the gain in that asset going forward there-
Connie Rathbone: Is tax free.
David Moore: Wow.
Connie Rathbone: Thank you, thank you for that wow. Yeah, there’s never been another program that I am aware of short of dying where you get a full step up in basis. Dying is pretty costly right, so this is a way to get that full step up in basis without dying first.
David Moore: From my perspective I look at two things. One, I said it before, I think it’s a great opportunity for some diversification, and it’s a lot more pigeonholed into things. So the like-kind requirements, even though it’s broad and 1031, nature versus form, you’re still sort of there. Like you said, the rest of the investment world really hasn’t been given that opportunity that 1031 provided.
Connie Rathbone: Right.
David Moore: But this is a real opportunity for people to get into some other things. The other thing that sort of hits me is that when we’re looking at building large assets—and we’ve done some large improvement exchanges together via a variety of different forms—we’re always looking at that timeline and it goes very quickly.
The one thing that I do want to ask about is when is the end of the time to get into one of these things?
Connie Rathbone: There are a couple of timelines that we can talk about. One of them is that you have to reinvest within 180 days. That’s similar to a 1031 exchange, but all you have to do is put your money into a qualified opportunity fund within the 180 days. Then the fund has 31 months to deploy or to spend that money.
David Moore: Okay, but we’re running into a time when you said 2019.
Connie Rathbone: Yes. Because of the fixed 2026 date, if you don’t invest by the end of 2019, you can’t get, get the second step up in basis of 5 percent because you need seven years. So that means that you can only get the 10 percent basis if you don’t invest by the end of 2019.
The reason that I say that the first two benefits are really nice but not compelling is that those are not the reason you invest. The reason you invest is to get the full appreciation tax free. So as we march toward 2026, the 5 percent benefit will go away at the end of 2019. And at the end of 2021, the 10 percent benefit will go away. But investing clear up to November of 2026, you still have the wow moment. You still have the tax-free appreciation during the hold period, so it’s still worthwhile just for that benefit.
When you are thinking of doing a 1031 Exchange, the sooner you consult the professionals at Equity Advantage, the better. Give David Moore and his team of experts a call today: 503-635-1031.