Opportunity Zones: An Investment Option for Capital Gains Tax

May 28, 2024 by Gordon Advisors

The federal Opportunity Zone program presents a unique opportunity for high net-worth investors to sell appreciated assets, such as real estate or stocks, and reinvest the gains into a Qualified Opportunity Fund (QOF), which, after 10 years’ investment, yields tax-free gains and offers the potential for unlimited tax-free growth.

What Are Opportunity Zones?

Opportunity Zones were established as part of the federal Tax Cuts and Jobs Act of 2017 to encourage long-term investment in low-income, economically distressed communities across the U.S. with this designation. The goal of Opportunity Zones is to stimulate economic growth, create jobs and revitalize underserved communities by attracting private capital to areas that may have previously been overlooked for investment opportunities. To attract investors, they can receive tax incentives for investing in development projects that drive new economic activity.

Investors benefit by deferring and potentially reducing capital gains taxes by reinvesting their profits from previous investments into QOFs, which invest in businesses, real estate or community development projects within the designated Opportunity Zones.

How Does the Program Work?

The Opportunity Zone program enables investors who sell appreciated assets to reinvest the capital gains into a QOF. Unlike a 1031 Exchange, there’s no need to invest in a similar property to defer tax on the gain.

To defer a capital gains, a taxpayer has 180 days from the sale date to invest the capital gain amount into a QOF. This fund, which can be structured as a partnership or corporation, is designed to invest in Qualified Opportunity Zone property. The taxpayer can invest both the principal and the recognized capital gain, but only the portion related to the capital gain will qualify for tax exemption on further appreciation of the Opportunity Zone investment.

Additionally, when a taxpayer receives a reported capital gain from a flow-through entity like a partnership, S-corporation or trust/estate, they can choose to begin the 180-day investment period on one of three dates: the last day of the entity’s taxable year, the same date that the entity’s 180-day period starts or the due date for the entity’s tax return without extensions for the year the capital gain was realized.

What Are the Tax Implications of Investing in Opportunity Zones?

Investors who have realized capital gains from the sale of investments or property can benefit from investing in Opportunity Zones. By reinvesting their capital gains into a QOF, investors can defer paying taxes on those gains until 2026 or when the fund is sold or exchanged, whichever is first, it reduces the amount of taxes owed on those gains by up to 15% and potentially eliminates taxes on any future gains from the QOF investment after 10 years from the initial investment.

Investing in Opportunity Zones can provide significant tax benefits, including deferring and potentially reducing taxes on capital gains. By investing in a QOF, taxpayers may elect to defer the tax on some or all capital gains during the 180-day period beginning at the date of sale/exchange.

In addition to the tax deferral and potential reduction in capital gains taxes, investing in Opportunity Zones can also provide a significant tax benefit in the form of tax-free gains on the appreciation of the investment. When a taxpayer holds their investment in a QOF for a minimum of 10 years, any additional gains realized from the investment are exempt from federal capital gains taxes. This tax-free appreciation can result in substantial investor savings and further incentivize long-term investment in economically distressed communities.

Investing in opportunity zones is not without risks. Investments in economically distressed communities may not always result in positive returns. In fact, they tend to be at the higher end of the risk-return continuum. Additionally, investors must commit to holding their investment in a QOF, which is an illiquid fund, for at least 10 years to benefit from the tax advantages fully.

Conclusion

The Opportunity Zone program offers investors a unique opportunity to sell appreciated assets and reinvest the gains into a QOF, providing potential tax benefits and incentives for investing in economically distressed communities. By deferring and potentially reducing taxes on capital gains, investors can contribute to the growth and revitalization of underserved areas while potentially benefiting from tax advantages. While risks are involved, including market fluctuations and the long-term commitment required, the Opportunity Zone program presents a promising avenue for investors seeking to make a positive impact while optimizing their tax strategies.

If you want to learn more about investing in Opportunity Zones and how it may benefit you as a taxpayer, contact Gordon Advisors today for personalized guidance and advice.