Investment returns often reward the patient investor. And now, the federal government is doing the same. A provision of the Tax Cuts and Jobs Act (TCJA) sets up an incentive program for investors who are willing to take a chance on long-term investments in economically depressed areas. The U.S. Treasury Department and IRS recently issued guidance and proposed regulations on the tax incentive.
The new law extends preferential tax treatment for investment in a Qualified Opportunity Zone (QOZ), a new federal designation for low-income areas. Governors of all 50 states and 5 U.S. territories, as well as the mayor of the District of Columbia, nominated census tracts for QOZ status, and the Treasury Department announced the final round of approvals in June. These tracts will retain their QOZ designation for 10 years. Click here for Opportunity Zone resources, including a list of approved QOZs.
Investors who have sold appreciated assets in recent months should weigh the risks and benefits of investing the gains into a Qualified Opportunity Fund (QOF), which is an investment vehicle created by the TCJA to facilitate investing in property or businesses within a QOZ. The tax benefits keep growing the longer the investment is held, so investors will be wise to do this risk-benefit evaluation as quickly as possible.
Four Levels of Opportunity Zone Tax Benefits
To understand why a QOZ investment may be lucrative, let’s break down the four main tax benefits of the QOZ program. When a taxpayer sells any capital asset and re-invests the capital gains into a QOF within 180 days:
- Tax on that capital gain is deferred until the sale of the QOF or until Dec. 31, 2026, whichever is earlier.
- After five years, the cost basis of the QOF investment increases by 10% of the original deferred gain (i.e., a 10% reduction of the deferred capital gain tax).
- After seven years, the cost basis increases by an additional 5%. Thus, after holding an investment in a QOF for seven years, you’ll only be taxed on 85% of the original deferred capital gain. Keep in mind, you won’t have to recognize that deferred gain until the earlier of the sale of the QOF or Dec. 31, 2026.
- After holding for 10 years, any post-acquisition appreciation of the QOF is exempt from capital gains tax.
Are Opportunity Zones the Right Opportunity For You?
QOZs are just the latest example of lawmakers encouraging investment in certain types of areas. Established state and federal programs include low-income housing credits, new markets tax credits, historic tax credits, and others.
As always, tax benefits should not drive investment decisions. Each investment must be evaluated on its own merits and growth potential. However, with more than 40% of U.S. census tracts nationwide characterized as low-income communities, some of those tracts are likely to be diamonds in the rough. And this new federal program offers investors incentives to hold their investments in these areas until they appreciate.
If you recently sold or are planning to sell appreciated assets, and you have the ability and patience to invest the gain for the long term, contact your CRI advisor to discuss the federal Opportunity Zone program, as well as other tax credit and incentive programs. Check back here for updates and further guidance on these rules.