Where are Opportunity Zones?
Governors in every state (and some districts and territories) have each designated land in their state as a Qualified Opportunity Zone. Looking for the substantial investment this designation brings, their stated hope is to spur investments and growth where it’s needed most.
Currently, more than 8,700 of these zones exist across the country. You can live in one state, and invest in a QOZ somewhere entirely differently. The Department of Housing and Urban Development’s website has a map of every qualified zone. Each zone, in bright pink, is dotted across the nation.
How It’s Used
For real estate investors who want to re-invest their money and not see it diminished by capital gains tax, this is an opportunity. It also holds the additional benefit of not requiring the investor to actually own property as a landlord. Whereas using the 1031 exchange as a means to defer capital gains taxes does not carry this benefit.
The capital gains transferred from a sold investment property into a Qualified Opportunity Zone investment can come from the sale of appreciated real estate, but is not limited to real estate gains. Stocks, bonds, cryptocurrency, an art collection – all can be appreciated assets that, when sold, carry capital gains. Any realized capital gain is eligible for investment in a QOZ.
Making a timely investment in this manner defers the payment of the tax until the subsequent sale of the investment or December 31, 2026, whichever comes first. Investors can also choose to hold the investment past the 2026 deferral deadline, with significant incentives to do so. Any investment held for a minimum of ten years will avoid any Federal capital gains tax on the QOZ investment itself, and may also eliminate state capital gains tax, depending on the states involved.
QOZ Options
Not only are there thousands of opportunities across the nation for a QOZ investment, there are a great many different kinds of investments possible. They include existing or start-up businesses; apartment buildings or multi-family housing; commercial or residential real estate; medical buildings or hotels. All offer opportunity for diversification of your investments. The limitations include golf courses, country clubs, liquor stores, casinos or massage parlors, among others.
Why a December 31, 2026 Deadline?
Unless Congress acts to extend the expiration on the legislation, the opportunity to invest in QOZs will expire December 31, 2026. The concept, however, was initially created with bipartisan support and it is entirely possible it will be extended. Either way, any investor who takes advantage of the opportunity now stands to benefit.
Important Benefits
Any accredited investor will tell you that deferring or even, as is possible here, eliminating capital gains taxes pays its own dividends. First and foremost, the tax-free growth on the investment is by far the largest of the benefits.
The critical qualifiers for investment in a QOZ is the investment of realized appreciation, or capital gain, that would otherwise be subject to Federal and, in some cases, state capital gains taxes. These gains must be invested within 180 days of being realized.
Done properly, the tax advantage is powerful. Payment of the gains tax on the original investment where the initial gains were realized is deferred until the expiration of the act on December 31, 2026, with the actual payment not due to the Treasury Department until the tax filing deadline on April 15, 2027. While relatively short lived if the act isn’t extended with a later date, it does allow the opportunity to put those gains to work earning interest in the interim.
The second, also significant tax advantage relates to gains realized on the Opportunity Zone investment itself. If the QOZ investment is held for at least ten years, investors can potentially earn significant profits without having to pay any taxes on them. The realized appreciation from a QOZ investment held for ten years will not be subject to capital gains tax.
What’s more, most QOZ funds plan to offer liquidity to investors early into the 10-year program, helping investors pay their future tax bill on the original capital gain.
The benefits keep coming! QOZs also have the potential to negate depreciation recapture. Depreciation recapture is currently taxed at 25%. This happens when an investor in a business property uses depreciation to write off some of the property’s value as it decreases over time; the IRS collects taxes on the financial gain the investor realizes by selling the depreciated property. The difference between the sale value of the asset and its depreciated value is thus accounted for. But taking the realized gain and investing in a QOZ fund has the potential to shield the capital gain from depreciation recapture.
A significant tax break can be realized, despite the many hoops you’ll have to jump through to invest in a QOZ. The rules and regulations around QOZs must be adhered to closely and do require the assistance of knowledgeable professionals with experience in this field.
Related Links
Articles:
How to be in real estate without being in real estate
Qualified Opportunity Zones: What you need to know
The 45-Day Window: How not to make a huge mistake with 1031 exchange
Navigating a 1031 Exchange With Mortgaged Property
These tax deferral tools are complicated and require significant expertise to realize the benefits and avoid the pitfalls. Planning Network Partners is dedicated to examining this and other opportunities as part of a larger picture of your whole financial health.
Contact Us for expert assistance.