What is an Opportunity Zone?
The Tax Cuts and Jobs Act of 2017 created a new investment vehicle called an Opportunity Zone. An Opportunity Zone is an economically distressed community that provides preferential tax treatment to long-term investors under federal tax rules. It is a tax-based program intended to spur investment and create jobs in troubled areas of the country.
To be designated an Opportunity Zone, a census tract must first be nominated by the state or other jurisdiction for this purpose and then be certified by the U.S. Treasury and the IRS. For an area to qualify as an Opportunity Zone it must be characterized by either a poverty rate of at least 20 percent, or a median household income that is less than 80 percent of the median household income of its neighbors. Opportunity Zones are required to have 90 percent (90%) of the Fund assets invested in Opportunity Zones.
In total, there are more than 8,700 certified Opportunity Zones. They are located in every state, and the IRS has published a list of tracts, by state, in Notice 2018-48.
There are three main tax benefits for investing unrealized capital gains in an Opportunity Zone investment.
The largest tax breaks went to those who invested in 2019. Another deadline is at the end of 2021. There are three parts to this tax break. The biggest and longest lasting break is that you pay no tax on capital gains realized in an opportunity zone investment, provided you hold the investment for at least 10 years. The second part is you can roll over gains from other investments into an opportunity zone and defer paying taxes on the rolled over gains until the end of 2026. The third part of the break is that the basis in your rolled over gain, when it’s taxed in 2026, is increased by 10% if you’ve been in the opportunity zone fund for five years, or by 15% if you’ve been in the fund for at least seven years, which is where the deadlines of 2019 and 2021 come in.
1. A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in an Opportunity Zone if the investment is held for at least 10 years. This exclusion only applies to gains accrued after an investment in an Opportunity Fund.
2. A temporary deferral in taxable income for capital gains reinvested in an Opportunity Zone. The deferred gain must be recognized on the earlier of the date on which the investment is disposed of or December 31, 2026.
3. A step-up in basis for capital gains reinvested in an Opportunity Zone. The basis is increased by 10% if the investment in the Opportunity Zone is held by the taxpayer for at least 5 years and by an additional 5% if held for at least 7 years, thereby excluding up to 15% of the original gain from taxation (the 10% basis bonus is only available until December 31, 2021 and the additional 5% for 7 years is no longer available).
The tax benefits of opportunity zones require investing original capital gains from another asset. Invested cash is not eligible for capital gains tax exclusion. Some funds require that you hold for 10 years, but the majority allow you to sell at any time.
The final date to receive any basis step-up on the original gain is December 31, 2021. After this date, the 10% step-up in basis after a 5-year hold goes away, as it is no longer possible to achieve a 5-year hold prior to the end of 2026.
Who Can Invest in a Qualified Opportunity Fund?
Individuals, multi-member LLCs, S corporations, partnerships and C corporations.
How does an Opportunity Zone Investment Compare to a 1031 Exchange?
There are significant differences between the tax benefits from an investment in an Opportunity Zone versus like-kind property that qualifies for a 1031 exchange.
Among the major differences are that, for a 1031 exchange, only your real estate assets qualify and the exchange must include the value of the asset and the gain. For an Opportunity Zone investment, all assets that give rise to a capital gain qualify and only the gain portion of the transaction must be reinvested.
|Opportunity Zone||1031 Exchange|
|Qualifying Gain||Virtually any short or long-term gain that is treated as a capital gain||Real estate only|
|Amount that must be reinvested||Gain portion only||Total sales price - including both the asset’s initial basis and gain|
|When reinvested gain is taxed||The earlier of when asset is sold or December 31, 2026||When asset is sold|
|When appreciation of reinvestment is taxed||Stepped up basis after 10 years||Stepped up basis upon death|
|Depreciation recapture subject to tax as ordinary income||No, if held greater than 10 years||Yes|
|How long to reinvest||180 calendar days||180 calendar days|
An investment in an Opportunity Zone Fund must be an equity investment received in exchange for cash or property. Debt instruments are not permitted.
IRS Opportunity Zones Frequently Asked Questions (FAQs) https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions