“Qualified Opportunity Zones” are creating quite a buzz lately. And for good reason! There’s major profit potential for real estate investors looking to take advantage of the capital gains tax credits that came along with the Tax Cuts and Jobs Act of 2017.
In essence, the Opportunity Zones tax bill introduced incentives to invest in the development of designated low-income areas throughout the country. The tax benefits are substantial, to be sure. But unsurprisingly, the ins and outs of this legislation are a bit difficult to digest.
Here are the basics.
A Beginners Guide to Qualified Opportunity Zones
Q: What are Qualified Opportunity Zones?
A: Qualified Opportunity Zones (QOZ) are designated areas that provide tax advantages for real estate investors.
Q: Who came up with this tax advantage?
A: Believe it or not, Sean Parker—the founder of Napster and former president of Facebook—is responsible. The tech billionaire was seeking a solution to investor cash sitting on the sidelines, cash that he believed could otherwise be invested in underdeveloped areas. He worked with senators to introduce and pass the legislation in the Tax Cut and Jobs Act of 2017.
Q: When are these tax benefits available?
A: They become available when an investment is sold, and the gain realized is invested in a QOZ. Unlike a 1031 Exchange, the investment is not limited to a real estate for real estate exchange. The gains could be from the sale of a business, stocks, bonds, or any investment with taxable gains.
It should also be noted, there is no requirement to reinvest the entire proceeds of the sale. You could potentially pocket cash and still defer all the gains by reinvesting only the gain portion of the proceeds.
Even better, depending on the amount of time you stay invested in the QOZ, the tax on the deferred gain could be reduced by up to 15 percent, and the new investment could be entirely tax-free at disposition! Plus, you have 180 days from the time of your investment sale to reinvest in a QOZ, giving you time to make that decision.
Q: Why should a QOZ interest me?
A: A QOZ allows you or your investors to exit a current investment with gains and defer capital gains taxes, resulting in potentially massive savings. If you own land or property in a QOZ, it may be worth more than you think.
Q: How do I take advantage?
A: Benefiting from a QOZ is easier than you might think. Simply sell an investment that has appreciated in value, and invest the gain in value into a QOZ.
Q: Where do I find Qualified Opportunity Zones?
The U.S. Department of Treasury, supported by the Community Development Financial Institutions Fund (CDFI Fund), has published both a list of Qualified Opportunity Zones and a map of all designated QOZs online.
Q: Where is the best place to find more information about Qualified Opportunity Zones?
The IRS has published an Opportunity Zones frequently asked questions on its website.
Q: How do Opportunity Zones work?
Here’s an example of how to take advantage of these economic opportunity zones and beat “the taxman.”
John has successfully navigated the long and winding road of the lawn maintenance business. He started his company from scratch, so his original basis in his business was $0. After working “eight days a week” and achieving a certain level of success with his company, he sells it to Paul for $1,000,000.
Great news for John, right?!
Now, I don’t want to spoil the party, but John’s $1,000,000 return on the sale of his business means he has to write a check for $260,000 to the government to pay his capital gains taxes.
The euphoria John felt about selling his company quickly turns to frustration, as his tax reality settles in. He turns to his tax accountant, George, for help.
George tells him about Qualified Opportunity Zones.
John calls a real estate investment buddy named Ringo. Ringo finds John a qualified opportunity. John buys the real estate.
Below are John’s options and the corresponding tax consequences, depending on how long he holds the investment:
- If John holds the investment for five years, he would defer the capital gain of $260,000 until the asset is sold. John would then get a 10% discount on his gain for investing in a QOZ. This leaves John owing $234,000 instead of $260,000, and he is able to defer the gain for five years.
- If he holds for seven years, the discount on his gain would be 15%. He would only owe $221,000.
- And, most impressively, if John holds the investment for 10 years in a QOZ, he would pay ZERO tax on any gains on appreciation from real estate investments in the QOZ.
Let’s say it plays out like this. John invested $1,000,000 into a Qualified Opportunity Zone. He holds it for 10 years, and sells it for $2,000,000.
John defers tax on the original investment until the time of sale and receives up to a 15 percent discount at that time. Plus, now he owes zero capital gains on the qualified investment portion of the sale, saving him $299,000 in capital gains taxes. The reason? It’s simply because he invested in a Qualified Opportunity Zone. AMAZING!
If you’re still reading this, you’re probably intrigued and have more questions. While this is a quick overview of the program, I’ve also included some helpful links below. If you have questions, feel free to reach out to me directly or comment below. Be sure to tune in next week for “The Flash Guide to Setting up a Qualified Opportunity Zone Fund.”
Intrigued? Do you have more questions?
Reach out in a comment below.