At Clark Schaefer Hackett we’ve been digging deep to uncover some of the lesser known opportunities businesses can benefit from and we found just that under the newly established IRC Section 1400Z. Considered by many as a hidden jewel, this provision includes a new incentive designed to spur economic growth in low-income communities. Taxpayers throughout the country will be able to put their unrealized capital gains to work by investing in Opportunity Zones.
- What is an Opportunity Zone?
The TCJA created new incentives for investments in designated areas of low-income communities called qualified Opportunity Zones. More than 8,700 communities in all 50 states, the District of Columbia and five U.S. territories have been designated as qualified Opportunity Zones. They’ll retain that designation until December 31, 2028.
- How many census tracts are in Ohio?
There are 320 separate census tracts in Ohio. To view a map of Ohio’s eligible tracts, click here.
- What is a Qualified Opportunity Fund?
Investors can form private investment vehicles, known as qualified opportunity funds (QOFs), for funding development and redevelopment projects in the zones. QOFs must maintain at least 90% of their assets in qualified Opportunity Zone property. Eligible qualified Opportunity Zone property includes investments in qualified opportunity zone stock, qualified opportunity zone partnership interest and qualified opportunity zone business property.
- What are the tax benefits for investors?
QOF investors are eligible for tax benefits. They can defer short- or long-term capital gains on a sale or disposition if they reinvest the gains in a QOF. The tax is deferred until the earlier of 1) the date the fund investment is sold or exchanged or 2) December 31, 2026.
If the investment runs five years, an investor will enjoy a step-up in tax basis equal to 10% of the original gain, so the investor will owe tax on only 90% of that gain. An additional 5% in basis is added at the seven-year point, cutting the taxable portion of the original gain to 85%.
In addition to the deferral of gain, an investor is eligible for an increase in basis of the investment up to its fair market value on the date it’s sold or exchanged, as described below. Depending on the transaction date of the initial sale to be deferred and the subsequent sale of the QOF investment, the taxpayer could eliminate up to 15% of the deferred gain and 100% of the gain attributable to the sale of the QOF. The tax benefits can be further enhanced when combined with other credits, such as the Low-Income Housing tax credit and the New Markets tax credit.
- Can you illustrate an example?
On day one, taxpayers start out with a fair market value equal to the invested gain, and a basis of zero. For example, if a taxpayer uses a $100,000 capital gain from the sale of land to invest in Qualified Opportunity Property, the fair market value of the property will be $100,000 but the cost basis will be zero. This means that if the property is immediately sold the $100,000 gain will be recognized. However, if the investment is held for 5 years, there will be a 10% basis boost. Now the gain if the property is sold will only be $90,000. Hold the investment for another 2 years (7 in total), and there is an additional basis boost of 5%. On December 31, 2026, deferred tax on the original gain is due. Assuming that the investment has been held for the required 7 years, this will be 85% of the original deferred gain. That means that 15% of the original gain will never be recognized. If the taxpayer keeps the original investment for at least 10 years, the property is bumped up to fair market value on the date of sale, and no post acquisition gain is recognized…ever.
Of course, there are more complications and nuances in the new law than are explained in this Q&A and interested investors must make sure they are meeting all of the requirements to achieve gain deferral and/or exclusion. Please contact your CSH advisor for more information on Opportunity Zones.
Thought Leadership & Resources
CSH articles and event slides:
IRS proposes regulations for Opportunity Zone tax incentives
Opportunity Zones Provide a Unique Investment Opportunity
Resources:
IRS Frequently Asked Questions: Opportunity Zones
Treasury’s Press Release on Proposed Regulations and Access to Download the Guidance
IRS’s Update on Special Rules for Capital Gains Invested in Opportunity Zones
