Investing in Opportunity Zones: How to Maximize Your Tax Incentives and Capital Gains

Investing in Opportunity Zones: How to Maximize Your Tax Incentives and Capital Gains

What is the Opportunity Zones Program?

The Opportunity Zones program is an exciting new program which provides tax incentives for capital gains on investments in specially designated areas. The program was created as part of the Tax Cuts and Jobs Act of 2017, which added a new section to the Tax code (26 U.S. Code § 1400Z) and aims to develop low-income communities in cities throughout the United States.

How are Opportunity Zones selected?

Opportunity Zones are selected by each state’s governor based on a number of factors, including average income and potential for economic development. They are then submitted to the U.S. Department of the Treasury where they are certified.

What are Opportunity Funds?

Opportunity Funds are investment vehicles that intend to invest at least 90% of their holding into partnership interests, businesses, or property within a designed Opportunity Zone. Opportunity Funds must invest in such a way as to improve the Opportunity Zone’s community. Examples include supporting local businesses or improving local buildings or living spaces.

What are the tax incentives of Opportunity Zones?

Those who invest in Opportunity Funds in qualified Opportunity Zones become eligible for substantial federal tax advantages. Investors can defer and reduce realized capital gains on the invested principal and potentially eliminate the capital gains tax on returns earned through sale of the investment(s). Funds invested no earlier the December 31st, 2018 will qualify as part of the Opportunity Zones program.

When one sells an appreciated asset, a capital gain is realized. This would normally result in a tax being levied on the sale of the appreciated asset. If that capital gain was realized inside an Opportunity Fund, however, the seller (read: investor) is able to minimize the tax substantially.

Specific Examples of Opportunity Zone Tax Incentives

Let’s say we have an investor named Bob. Bob is very excited about the Opportunity Zones program and has invested in an Opportunity Zone. His investment has done well and now he’s ready to sell his asset.

Incentive Number One

The first way Bob can capitalize on Opportunity Zones tax incentives is by moving his realized capital gains into a qualified Opportunity Fund within 180 days of selling his asset. This means he can defer paying capital gains taxes on his gain until December 31, 2026 – or until such a time as he sells his Opportunity Fund investment, whichever comes first. By doing this, Bob is free to put a larger amount of capital to work for a longer period of time. Whereas he might otherwise have been forced to use funds to pay taxes upfront, he is now free to invest these funds and earn returns for several years. By doing this, Bob has greatly increased the earning power of his money.

Incentive Number Two

Let’s say instead of selling his Opportunity Fund investment right away, Bob decides to hold on to it for a little while. If he retains his Opportunity Fund investment for at least five years prior to December 31, 2026, he is eligible to reduce his deferred capital gains tax liability by 10% through a step-up in basis. If Bob decides he wants to hold on to his Opportunity Fund investment for another two years, then he’ll be eligible to reduce his deferred capital gains liability by another five percent. In summary, if Bob holds on to his Opportunity Fund investment for seven years prior to December 31, 2026, he’ll be able to reduce his tax liability on all deferred capital gains invested in said fund by a total of 15%.

Incentive Number Three

What if Bob really isn’t in a hurry to sell his Opportunity Fund investment? Well, if he holds on to that investment for another three years (that’s ten years total – Bob really is patient) he will be eligible to pay absolutely nothing in capital gains taxes on any appreciation from the original Opportunity Fund investment. His gains now qualify for permanent exclusion from capital gains taxes.

Bob reinvests for increased incentives

If the first incentive was enough for Bob, he could have sold his Opportunity Fund investment and deferred his capital gains tax until December 31, 2028. But, if he instead decided to be patient, he would be able to reinvest his realized capital gains into an Opportunity Fund and benefit from constantly improving tax incentives. The longer he holds the investment, the better his incentives become.

Maximizing your Opportunity Fund benefits

To be like Bob and maximize the benefits and incentives provided by your Opportunity Fund, there are a few things you can do. First of all, you need to invest in your desired Opportunity Fund(s) no earlier than December 31, 2018. Next, you’ll have to elect on your tax filing to show capital gain rollover into an Opportunity Fund. By doing this, you won’t have to pay capital gains tax on your gains until April 15, 2027. Last, you’ll sell your Opportunity Fund, tax-free, after holding it for ten years. If you invested on December 31, 2018, then to reap this benefit, you would sell no earlier than December 31, 2028.

Invest in your Opportunity Fund expertly

While Opportunity Funds are an exciting and new investment vehicle, they can also be complex. There are specifically outlined qualifications Opportunity Funds must meet including:

  • At least 90% of assets must be located and invested in qualified opportunity zone property;
  • Properties only qualify if acquired after December 31, 2017
  • Qualifying assets must be equity investments, not debt; and
  • The original use of such property must commence with the Opportunity Fund, or the fund must substantially improve the property within 30 months of acquisition

Over the coming months, the IRS and Treasury Department are set to release further guidance on the implementation of this program. Here at Escalante Yormack Law, we will follow these updates closely to ensure we’re ready to expertly serve all of your Opportunity Fund investments needs with expert opinions.

To best prepare for Opportunity Fund investing, ask questions, and learn more, contact us today at adam@eylawyers.com.

About Escalante Yormack Law

Based in Miami, Escalante Yormack Law, PLLC is a boutique law firm founded by real estate, corporate and business lawyers. Our team consists of partners, Frank Escalante, Esq. and Adam Yormack, Esq., of counsel, Aviv Hillo, Esq., and law clerk, Alejandro Fernandez-Lovo, J.D. The team has 50 years of joint experience in our focused Practice areas, Real Estate, Litigation, Corporate and Emerging Technology, and Franchise and Distribution