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Opportunity Zones: The Next Tax Shelter?



Mitchell R Miller

The 2017 Tax Cuts and Jobs Act provided new benefits to taxpayers to encourage investment in economically disadvantaged areas. The benefits are extensive but they require careful compliance with the regulations governing the new program.

The Opportunity Zone program permits people to invest the proceeds of a recent capital gain in one or more designated “Qualified Opportunity Zones” to defer and reduce that original capital gain.

A. Here’s how it works:

1. You sell a capital asset (stock, real estate, artwork, etc.) in 2019:

Sale Price        $50,000
Basis                   10,000

Capital Gain   $40,000

2. You invest $40,000 in a “Qualified Opportunity Fund” (QOF – explanation below) within 180 days of the date of sale.

3. Your gain of $40,000 is not taxed until the earlier of:

a. The date you sell your interest in the QOF; or

b. December 31, 2026

4. Your gain of $40,000 is reduced by 10% to $36,000 if your hold the QOF investment for five years.

5. Your gain of $40,000 is reduced by 15% to $34,000 if your hold the QOF investment for seven years.

B. How about your investment in the QOF?

If you hold it for at least 10 years, your gain will be zero ($0).

1. For example, let’s say your $40,000 QOF investment grows to $100,000 in 10 years.

2. Your total tax is:

Gain on sale of original asset $40,000
Less 15% reduction                       6,000

Taxable gain                              $34,000

Tax on gain @ 20% =                                              $6,800

Gain on Sale of investment in QOF:

Sale Price                                  $100,000
Basis                                            $40,000

Capital Gain                               $60,000
Tax on gain @ 20% x 0 =                                                $ 0

Total Tax                                                                     $6,800

3. Compare that to what you would have paid if you had invested your original gain into a regular investment:

Gain on sale of original asset $40,000
Tax on gain @ 20% x 40,000 =                             $8,000

Gain on sale of new investment
Capital Gain                              $60,000
Tax on gain @ 20% x 60,000                                $12,000

Total Tax                                                                    $20,000

Quite a difference!

4. Of course, you will have to pay your state income tax on the gain as well. Some states are going along with the Opportunity Zone program, some are not. Consult your professional tax advisor.

C. What is a Qualified Opportunity Zone (QOZ)?

1. The Tax Cuts and Jobs Act of 2017 introduced the Opportunity Zone program. The idea was to encourage investment in disadvantaged areas to stimulate their economies. State governments may designate not more than 25% of the low-income areas in their state as Opportunity Zones. While most Opportunity Zones are low-income areas, up to 5% may be areas adjacent to low-income areas.

2. Before investing, you will want to check the area in which the project will take place, and make your own determination of the potential success of the area.

D. What is Qualified Opportunity Zone Property?

1. Interest in a business earning more than 50% of gross income from active conduct of a trade or business in a QOZ.

2. Rental real estate qualifies as a trade or business for QOZ purposes!

3. 70% of tangible personal property of the business must be new property brought into the QOZ, or a substantial improvement (doubling the basis) of existing QOZ property such as rental real estate.

4. No more than 5% cash assets, plus a reasonable amount of working capital.

5. Can be an interest in a partnership, LLC, corporation, or direct ownership of tangible assets (e.g., store, factory, building).

6. Must be acquired in original issue for cash – can’t buy an existing business, can’t form a business by contributing property in exchange for stock or partnership interest.

7. Can’t be a “sin business” (liquor store, bar, golf course, country club, massage parlor, hot tub, suntan, or gambling joint – doesn’t exclude weed shops!)

E. What is a Qualified Opportunity Fund?

1. An investment fund (public or private) 90% of which must be invested in QOZ property.

2. Will invest in QOZ entities which must qualify as above.

3. Must comply with all securities requirements.

4. Must be partnership or corporation.

F. Can you do this by yourself?
Yes, but there are many requirements – those above and more – with which you must comply. Unless you are an expert in the above areas, this is not generally a good idea.

Have a question? Contact Mitchell R Miller.

 

One thought on “Opportunity Zones: The Next Tax Shelter?

  1. Avatar Tim Shields says:

    The part I don’t get is this. Lets say I have $1,000,000 CG from sale of closely held shares. I buy a piece of property in a zone for $1M in 2026 I will have to pay CG tax on that $1M minus the break they give you of what%??? because I haven’t had the fund for 10 yrs let’s say after 7yrs as of today 2019 to 2026 is what percent. In the meantime I have to improve the property by how much $ in 30 months so now I have $2M in the property and I still have to come up with CG in 2026 of 20% $1M minus the break they give you of only 10% because I haven’t had the property for 10 yrs to get maximum benefit of 15% so now I have a break of 20% x $1M = $200,000 minus the 10% break which is 10% of the original CG of $1M or $1M x 10% = $900,000 or my tax I have to pay in 2026 = $180,000. So here I am in 2026 I’ve had to pay out $2,180,000 to save $20,000 in taxes. I really like that I don’t have to pay any CG after holding it for 10yrs but damn.

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