The 2017 Tax Cuts and Jobs Act established the Opportunity Zones incentive as a new investment tool. The Opportunity Zones incentive is designed to stimulate development in disadvantaged areas throughout the nation and release unrealized capital gains into the market.
What is an Opportunity Zone and a Qualified Opportunity Fund?
An Opportunity Zone is an identified economically distressed community where under certain conditions new investments may be eligible for favored tax treatment. These designated zones are located throughout all 50 states, the District of Columbia, and five U.S. territories.
A Qualified Opportunity Fund is the investment vehicle established for investing in property located within an Opportunity Zone. To become a Qualified Opportunity Fund an eligible corporation or partnership self-certifies by filing Form 8996 with its federal income tax return.
Why invest in an Opportunity Zone?
The Opportunity Zones program affords three tax incentives when capital gains are invested in designated areas through a qualified Opportunity Fund:
1. Temporary Deferral of taxable income where capital gain is reinvested into an Opportunity Fund. This deferred gain must be recognized by December 31, 2026 or the date on which the opportunity zone investment is disposed, whichever occurs first.
2. Step-Up In Basis on capital gains reinvested in an Opportunity Fund. The basis is increased by 10% if the taxpayer holds the investment in the Opportunity Fund for 5 years and by an additional 5% if held for 7 years. The years held requirement must be met prior to 12/31/2026 to qualify.
3. Permanent Exclusion on all capital gains and appreciation from investment to sale if an investment is held in an Opportunity Fund for at least 10 years. To receive tax free appreciation you must sell by the end of 2047 and only the appreciation attributed to the portion of the investment made with tax deferred gains is eligible.
Various types of assets that could qualify for deferred gain include but are not limited to: stocks, bonds, partnership interests, real property, and tangible property used in a trade or business.
How do I get started?
The key to receiving the Opportunity Zones incentive is the investment of capital gains into a Qualified Opportunity Fund. The initial investment into an Opportunity Fund must occur within 180 days of the realized gain. Unlike the deferral of gain through an IRC 1031 tax deferred exchange, you do not need a qualified intermediary to invest funds into a Qualified Opportunity Fund. In some instances, a Qualified Opportunity Fund may be treated as a security, in which case all existing rules and regulations for securities apply.
A Final Thought – The Opportunity Zone incentive provides an opening to move gains into new investments where that gain may otherwise be kept of the market. This is particularly beneficial where gains from other asset classes are being invested. However, in most scenarios where the sale of real estate is contemplated a 1031 exchange still affords the best option to defer a gain by investing in real property. If an exchange is initiated but a replacement property cannot be identified within the 45-day period those funds can always be redirected into a Qualified Opportunity Fund.
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What is an Opportunity Zone?
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