Posted about 2 months ago

Opportunity Zone Tax Benefit Decreases A Bit At 12/31/2019 Deadline

I’m in the process of closing the sale of a rental property which has some built-in capital gain. The whole process has taken about 6 months (from the time my tenants moved out at the end of May). Assuming I can close by December 31, 2019, I will be able to defer the gain by putting it into a Qualified Opportunity Fund (QOF) within 180 days of the sale. However, if my sale is not completed for tax purposes by December 31, 2019, I will forgo a 5 percent step-up in basis on my initial gain. [If you missed my first 3 posts, I provided an introduction to the new Opportunity Zone (OZ) tax law and my decision-making process in setting up my own QOF there.]

Please note: my discussion of tax law below should not be interpreted as legal advice. As always, you should consult your legal and/or tax advisor for advice on how this law may apply to your personal circumstances.

For those of you thinking about taking advantage of the OZ tax benefit, it’s not too late to maximize the benefit (i.e. sell by December 31, 2019), especially if your capital assets are fairly liquid, like public company stock or mutual funds. If you’re looking to sell real estate, it could be challenging to get it done in the next month.

Don’t despair though. The bulk of the OZ tax benefit will still be available. If you sell capital assets with built-in gains between January 1, 2020 and December 31, 2021, you will still get a 10 percent step-up in basis on the original gain (assuming you hold your QOF investment for at least 5 years) plus a full step-up in basis (i.e. no federal capital gains tax) on your QOF investment (assuming it appreciated in value after 10 years).

Let’s just say you had the foresight to invest in Amazon stock way back when and you’re now sitting on $1 million of built-in capital gains. You would most likely be in the 20% federal capital gains tax bracket (because of the size of the gain itself), and therefore your federal capital gains tax bill would be $200,000 upon liquidation.

If you sold your stock before the end of the year and rolled that $1 million gain into a QOF within 180 days, assuming you held your QOF investment for at least 7 years, your step-up in basis would be 15 percent or $30,000 in tax savings (15% of $200,000 in tax). If instead you sold your stock in 2020 or 2021, your step-up in basis would be 10 percent or $20,000 in tax savings. You give up $10,000 in tax savings on a $1 million capital gain by not selling in 2019. If your capital gain is $100,000 instead of $1 million, then you give up $1,000 in tax savings (even less if you are in the lower 15% federal capital gains tax bracket).

As mentioned in previous blog posts, the big tax savings under the OZ tax law comes from the appreciation of your QOF investment. If you just held your Amazon stock and let it appreciate to $2 million in capital gains over time, you would have an additional $200,000 of federal capital gains tax on that incremental $1 million in gain (when you eventually liquidate the stock). On the other hand, if you took your $1 million in gain and invested it in a QOF which appreciates to $2 million in value, your incremental $1 million in gain would have $0 of federal capital gains tax (assuming you held the investment for at least 10 years). You would save $200,000 in tax on the eventual liquidation of your investment.

Of course there are other factors that would come into play like the growth rate of Amazon stock vs a QOF investment over time. However, if you were looking to diversify your portfolio and reduce volatility, selling a high flying stock like Amazon after a 10-year bull run and rolling it into OZ real estate via a QOF could help you achieve those goals.

Bottom line: you can save some tax under the OZ tax law by liquidating assets with built-in capital gains by December 31, 2019, but even if you don’t make that deadline, there is still substantial tax benefit that you can derive by liquidating in the future. You will have until December 31, 2021 to get a 10 percent tax savings on your initial capital gain which is timely invested into a QOF and held for at least 5 years. And you will still have until December 31, 2026 to get federal tax-free appreciation on your QOF investments held for at least 10 years. Enjoy the holiday season and don’t stress too much on this particular year-end deadline!