Advanced Taxation Question Related to Opportunity Zones

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Advanced Taxation Question Related to Opportunity Zones

Jason Velie
Rental Property Investor · Rocky Point, NC · Member since 2017 · 70 posts · 84 votes

Hello everyone! I believe this is my first post.

Let me start by saying that I will ask my CPA these questions, but I want to know what I’m talking about a little better first so I’ll know exactly what to ask.

This year, I completed my first flip and netted about $26k before taxes.

Earlier this week, I bought a rental (singlewide with land) for $15k, and I’ll put in about $3k to replace the septic lines and that’s it. Both the flip and the rental are near Wilmington, NC.

Listening to a BP podcast earlier today, I learned about Opportunity Zones, which I’ve never heard of before. I then looked up my local Opportunity Zones, and it turns out that both my flip and my new rental are in opportunity zones. With that said, here are my questions:

1) Am I understanding correctly that I will not have to pay any capital gains taxes on the rental if I keep it for at least 10 years? (The trailer is on a permanent foundation and deeded with the land as real estate.)

2) Is there a way my CPA can consider my $18k investment in the rental as coming from the $26k flip profit so I won’t have to pay income tax on that $18k?

3) Are there any other creative tax solutions that I could utilize this tax year since the flip and rental are both in Opportunity Zones?

Thanks!

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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
5y
Originally posted by @Jason Velie:

Hello everyone! I believe this is my first post.

Let me start by saying that I will ask my CPA these questions, but I want to know what I’m talking about a little better first so I’ll know exactly what to ask.

This year, I completed my first flip and netted about $26k before taxes.

Earlier this week, I bought a rental (singlewide with land) for $15k, and I’ll put in about $3k to replace the septic lines and that’s it. Both the flip and the rental are near Wilmington, NC.

Listening to a BP podcast earlier today, I learned about Opportunity Zones, which I’ve never heard of before. I then looked up my local Opportunity Zones, and it turns out that both my flip and my new rental are in opportunity zones. With that said, here are my questions:

1) Am I understanding correctly that I will not have to pay any capital gains taxes on the rental if I keep it for at least 10 years? (The trailer is on a permanent foundation and deeded with the land as real estate.)

2) Is there a way my CPA can consider my $18k investment in the rental as coming from the $26k flip profit so I won’t have to pay income tax on that $18k?

3) Are there any other creative tax solutions that I could utilize this tax year since the flip and rental are both in Opportunity Zones?

Thanks!

1) no
2) no

Just buying a property in a OZ doesn’t mean anything. Also, only cap gain can be deferred, not ordinary flip income.


there are 10s other requirements needed to properly establish and operate the OZ fund. 

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    5y
    Originally posted by @Jason Velie:

    Hello everyone! I believe this is my first post.

    Let me start by saying that I will ask my CPA these questions, but I want to know what I’m talking about a little better first so I’ll know exactly what to ask.

    This year, I completed my first flip and netted about $26k before taxes.

    Earlier this week, I bought a rental (singlewide with land) for $15k, and I’ll put in about $3k to replace the septic lines and that’s it. Both the flip and the rental are near Wilmington, NC.

    Listening to a BP podcast earlier today, I learned about Opportunity Zones, which I’ve never heard of before. I then looked up my local Opportunity Zones, and it turns out that both my flip and my new rental are in opportunity zones. With that said, here are my questions:

    1) Am I understanding correctly that I will not have to pay any capital gains taxes on the rental if I keep it for at least 10 years? (The trailer is on a permanent foundation and deeded with the land as real estate.)

    2) Is there a way my CPA can consider my $18k investment in the rental as coming from the $26k flip profit so I won’t have to pay income tax on that $18k?

    3) Are there any other creative tax solutions that I could utilize this tax year since the flip and rental are both in Opportunity Zones?

    Thanks!

    1) no
    2) no

    Just buying a property in a OZ doesn’t mean anything. Also, only cap gain can be deferred, not ordinary flip income.


    there are 10s other requirements needed to properly establish and operate the OZ fund. 

    [email protected]941-914-7779
    INVESTOR FRIENDLY CPA®5241 Reviews
    WebsiteView Page
    TaxMD™ | AI-Powered Tax Planning
    WebsiteView Page
    2Reply
  • Jason Velie
    OP
    Rental Property Investor · Rocky Point, NC · Member since 2017 · 70 posts · 84 votes
    5y

    @Ashish Acharya

    But “flip income” is capital gains, isn’t it? It’s short term capital gains, which is taxed as ordinary income, but to my knowledge it’s still a form of capital gains.

    Also, I believe I meet those other requirements, such as purchased by an LLC, keeping of clearly separate records, etc.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    5y
    Originally posted by @Jason Velie:

    But “flip income” is capital gains, isn’t it? It’s short term capital gains, which is taxed as ordinary income, but to my knowledge it’s still a form of capital gains.

    No, it's not. It's dangerous to make tax decisions based on one podcast without a solid foundation of understanding real estate taxation. 

    Like with everything in life, the basics (such as the fact that flips do not generate capital gains) should come before exploring advanced topics (like OZ). Learn to ride a bike on a flat surface before attempting a downhill backflip.

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  • Jason Velie
    OP
    Rental Property Investor · Rocky Point, NC · Member since 2017 · 70 posts · 84 votes
    5y

    @Michael Plaks

    No one is making decisions based on a single podcast. Forgive me for trying to learn.

    The flip and rental purchase have already been completed, and they’re incredible deals regardless of how I’m taxed on them. They’re in the past. Already done. Again, no one is making any future decisions based on the answer to my questions. I simply heard of a tax concept that I thought might be applicable to what I’ve already completed, and came here to learn more about it before wasting my CPA’s time.

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    5y

    Whether or not it's capital gain vs ordinary income subject to SE tax is the million dollar question.

    Not enough information was given here to make that determination, which is based upon fact and circumstance.  And, intent matters, but, by itself, is not controlling.  Therefore, this really is something you should be discussing with your CPA.

    The problem seems less about the nature of the first property's sale income, but rather that the second property was not purchased by a QOF.

    We can't do backward tax planning in this area.

    The QOF needs to be established before the second property is purchased, and there are several hoops you need to jump through.  I'd encourage you, again, to speak with your CPA.

    2Reply
  • Jason Velie
    OP
    Rental Property Investor · Rocky Point, NC · Member since 2017 · 70 posts · 84 votes
    5y

    @Eamonn McElroy

    Thanks Eamonn, this is the type of feedback I was looking for. I don’t know what I don’t know.

    I didn't know about Opportunity Zone Funds, but I just looked them up. My LLC is not one of these funds, so that confirms that I can't benefit from that tax strategy on these deals.

    In regards to the STG vs Income question, based on what I’ve read on the IRS’ website, the proceeds from my flip would be considered STG, because the IRS wouldn’t consider me a dealer. A couple of reasons why is:

    1) The proceeds from the flip only a small portion of my earning for the year (I have a full time W-2 career), so it doesn’t meet the “majority of earned income” qualification; and

    2) The sole purpose of the LLC is not flipping. I also own rentals in the LLC.

    Now I know what to discuss with my CPA. I won’t bother him about Opportunity Zone Questions. Thanks again!

    1Reply
  • Scott McIntosh
    Attorney · Lexington, KY · Member since 2019 · 41 posts · 37 votes
    5y

    @Jason Velie -- if the LLC you created to purchase the rental is a partnership or corporation and doesn't own anything other than the OZ property you described, its probably not too late to structure it as a QOF. Any partnership or corporation can self-certify as a QOF on the entity's first tax return, so assuming you created the entity in 2020, you've still got until ~ March 15th, 2021 to do so. There are some other requirements around language in the company's operating agreement, but like the self-certification, that's likely something that could be done at this stage, too.

    The other commenters are correct in stating that the OZ incentive is complex and requires careful planning.  In my opinion, the tax savings probably won't justify the complexity if this is the only OZ property you intend to acquire.  That said, the program is open to new investment until the end of 2026, and established QOFs can continue to acquire OZ property and benefit from the tax-free appreciation and avoidance of depreciation recapture benefits the program provides until the end of 2047.  So if you see this as the first of several OZ properties you'd like to add to your portfolio, it may be worth the time and expense of professional advice to get it right now.  

    1Reply
  • Jason Velie
    OP
    Rental Property Investor · Rocky Point, NC · Member since 2017 · 70 posts · 84 votes
    5y

    @Scott McIntosh

    Thanks, Scott. Very good info.

    The LLC I created is a sole proprietorship, so it doesn't require its own tax return.

    Also, I learned that these purchases don’t meet the other requirements. I.E. they’re not new construction, and my rehab budgets were not equal to the amount of the purchase prices.

    I do intend to purchase more in these areas, because I know them very well, and I’m very bullish on the appreciation in these areas. They’re not rough areas; they’re just slightly rural, but growing very quickly. However, it seems to only work for a QOF if it’s new construction or major rehab.

    I might just go ahead and consult with my attorney and my CPA about setting up a QOF now, so I’ll be ready to use it when the right property comes along. I can’t imagine that I’d go 6 years without finding a property that I’d want to buy in it. Since my primary focus is rentals, it’s very intriguing that I could potentially pay zero capital gains tax if I correctly hold properties for 10+ years .

    That raises another question though.

    Let’s say I successfully create a QOF and correctly buy 5 properties inside of it within the next 6 years. Then let’s assume the new president’s administration decides to repeal this tax incentive. Would I be grandfathered in? Or is that just a risk I’d have to take, knowing that I could still have to pay capital gains tax regardless?

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    5y

    @Jason Velie

    Careful planning is required for you to take advantage of the benefits provided by qualified opportunity zones.

    There are a couple requirements of a QOF
    1) Using capital gains to fund the business
    2) buying a property within a qualified opportunity zone
    3) proper allocation of business assets(QOZ property vs non-QOZ property)
    4) Proper amount of rehabilitation done to the property
    5) holding period

    Good luck!

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