By Peter Mastrantuono
Individuals looking for ways to combine their investing with making a positive social impact, or simply good old-fashioned tax breaks may find no better way to accomplish this than by investing in Opportunity Zones.
Opportunity Zones were established with the passage of the Tax Cuts and Jobs Act of 2017 to provide tax incentives for directing private investment into economically distressed communities across the United States.
Since its enactment, there have been 249 Qualified Opportunity Funds created, with a total investment capacity of $56 billion, according to OpportunityDb, an education and data analysis site.
Qualified Opportunity Zones: An Overview
A Qualified Opportunity Zone is established by first being nominated by a state or U.S. territory. The Treasury Department then reviews each candidate zone to certify that it qualifies for the program. There are currently over 8,700 Qualified Opportunity Zones in all 50 states, Puerto Rico and several U.S. territories.
Here’s how the program works:
- Individuals are able to defer and potential reduce capital gains and qualified 1231 gains (i.e., sale of a property) that would be considered recognized income prior to January 1, 2027 and are not transactions with a related person.
- Taxpayers have generally 180 days to reinvest any realized gains into a Qualified Opportunity Zone Fund in order to defer those gains for tax purposes. (The reinvestment clock is different for flow-through entities, such as partnerships or trusts.) Individuals must reinvest both the returned principal and realized capital gains to be eligible for the tax exemption.
- Individuals will receive a 10% step-up in the tax basis after five years, with an additional 5% step-up after seven years. (Note: For investors to take full advantage of the 15% step-up in basis, it would have required an investment by the end of 2019.)
- Any appreciation on a Qualified Opportunity Zone investment will be tax free, provided the investor remained invested for at least ten years.
- The proceeds from the sale of any asset, stocks, property, art, etc., can be used to reinvest in a Qualified Opportunity Zone Fund.
- To qualify as a Qualified Opportunity Zone Fund, the fund must be organized as a corporation or partnership for the purpose of investing in Qualified Opportunity Zones and hold no less than 90% of its assets in qualified Opportunity Zone property.
- The Fund must also meet certain initial and ongoing investment requirements, including a requirement that if an existing property is bought substantial improvements must be made to it and exclusions with respect to eligible businesses (e.g., investments in golf courses, massage parlors, gambling facilities and liquor stores, among others, are proscribed investments.)
The requirements surrounding investments in Qualified Opportunity Zones involve complex tax considerations, and as such individuals should consult with their tax advisor to determine if such investments make good tax planning sense. If these investments are deemed to be appropriate, individuals should work with a financial advisor to find a fund that meets their investment objectives, risk tolerance and any social impact goals they may have.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.