Opportunity Zones: Benefiting From This New Way of Deferring (and Excluding) Capital Gains

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Thanks to the recently passed Tax Cuts and Jobs Act of 2017, investors looking to defer capital gains have a new vehicle to provide substantial tax benefits, all thanks to something called Opportunity Zones (OZ) and Opportunity Zone Funds that invest within these areas.  Qualified OZ fund investments can generate multiple levels of tax relief by deferring and reducing gains already incurred -- in addition to creating tax free gains on the new investment.  This provision has not been widely publicized despite its potential for monumental tax savings!

What is an Opportunity Zone and Where are They Located?

An Opportunity Zone (OZ) is a specially designated area based on poverty rates and median income levels. The purpose of the OZ Funds is to promote long-term investments in low-income communities nationwide. In June 2018, over 8,700 census tracts across the U.S. were certified as opportunity zones by the Department of Treasury. California alone has 879 opportunity zones.

You can click on links below to see specific Opportunity Zones in your area.

How Does it Work?

For those who feel an Opportunity Zone Fund investment may be a good option, here is how to proceed:

  1. You invest some or all of your rolled-in capital gain from the sale of real estate or other capital asset (stock, partnership interest, etc.) into an Opportunity Zone Fund within 180 days of the sale that generated the gain.
    • OZ funds are being created as you read this. Small developers to the big equity firms will likely be entering this space and offering OZ fund investments.
    • You may also be capable of starting your own OZ fund.
  2. Decide if you want to invest in an OZ fund or if you’d like to start your own. If the latter, you need to immediately:
    • Learn the requirements of the OZ fund
    • Begin the hunt for the right real estate or business opportunity investment within an OZ.
  3. If the former, you need to begin searching for the right OZ fund for you and your investment objectives.

Tax Benefits

The investor who timely invests some or all of his gain into an OZ Fund within 180 days receives the potential of three distinct tax benefits. First, any rolled-in gain is deferred until December 31, 2026, or the date of the OZ fund sale, whichever is sooner. Second, this rolled-in (deferred) gain is reduced over time (by as much as 15%). Lastly, any new economic gain made within the OZ fund itself is tax- free if the investment is held at least 10 years.  There is no limit on this tax-free amount!

At a Glance Timeline for Opportunity Zone Tax Benefits

  • Already-incurred gain is deferred until Dec 31, 2026 (8-year deferral!)

  • This deferred gain is reduced by 10% after 5 years

  • This deferred gain is reduced another 5% (15% total) after 7 years

  • After 10 years, any new gains earned within the OZ fund are never taxed at all!

Scenario:

So, let’s say you sell property for $1 million that generates $400K in gain. You then take that $400K and invest it into an Opportunity Zone Fund within 180 days.

  • Because you timely invested in OZ Fund, you defer paying tax on your $400K gain from April of 2019 to December of 2026 (nearly 8 years).

  • If investment in an Opportunity Zone Fund is held at least 7 years, instead of recognizing $400K of gain, you would only recognize $340K of it ($400K x 15% basis reduction = $60K gain reduction), come December 31, 2026.

  • If your investment is held for at least 10 years and the $400K investment appreciates into a $1.2M value, then this $800K new gain would not be taxed at all!

At Ghirardo Real Estate Group, we feel investing in an Opportunity Zone Fund is a great alternative to a 1031 exchange, or at the very least, a solid backup plan to a failed 1031 exchange.  This is because it gives the investor more options to defer taxes, and options are always a good thing.

Because this law is so new, we anticipate much more guidance and interpretation in the coming months. For your reference, below is a short list of our initial questions we have already asked the IRS for clarification on:

  • Does Section 1231 gain from the sale of investment real estate (which is generally treated as capital gain) qualify as gain that can be deferred by investing into a Qualified Opportunity Zone Fund?

  • Does Section 1250 depreciation recapture gain also qualify for deferral by investing into a Qualified OZ fund?

  • If a taxpayer disposes of investment real property but a 1031 Exchange Qualified Intermediary substitutes in as the Seller to hold the relinquished property proceeds (like nearly all 1031 exchanges), and then taxpayer ultimately fails in his efforts to complete a 1031 exchange into replacement property – does the 180-day period in which to reinvest proceeds into qualified OZ Fund begin when the taxpayer actually receives his sales proceeds from the Qualified Intermediary? This rather than from the original sale date of the property?

  • Can ordinary income from the sale of real estate primarily held for sale qualify for deferral by investing into a Qualified OZ fund?

In our next blog post, we will discuss the specific requirements of an Opportunity Fund and perhaps have answers back on the above questions that we can share with you. In the meantime, feel free to call us with any questions you have on Opportunity Zone Funds. We are happy to share our knowledge.

Steve Ghirardo, Founder
Ghirardo Real Estate Group
steve@ghirardore.com
(415) 599-4900