The Tax Cuts and Jobs Act (TCJA), passed on December 22, 2017, lowered taxes on both individuals and businesses by expanding the tax brackets, introducing the Qualified Business Income deduction, and lowering the corporate tax rate. Also included in the TCJA was the introduction of the Opportunity Zones under IRS Codes 1400Z-1 and 1400Z-2. The Opportunity Zones offer generous tax breaks that were introduced to “spur private investment in distressed communities” by either lowering or completely eliminating capital gains depending on how long you hold the qualified investment.
What is a Qualified Opportunity Fund?
A Qualified Opportunity Fund can be either a corporation or a partnership that invests in property or a business within the qualified opportunity zone. Anyone can elect to become an Opportunity Fund by self-certifying through the completion of an IRS form (soon to be released) and attaching the form to their tax return. Another huge benefit is that you can apply unrealized (or realized if done within 180 days) gains from a stock portfolio or multiple investments to invest in an Opportunity Fund. This similar to a 1031 exchange where you exchange one property for another and defer the capital gains tax, but much better because if you can use gains from a stock portfolio and you can eliminate capital gains tax if you hold the investment long enough. The Opportunity Fund could then invest in assets like an apartment building, office space, coffee shop, or a fund that invests at least 90 percent of its assets in qualified opportunity zones. Lastly, you do not have to live in an opportunity zone to take advantage of this new tax break.
How Long Do I Have to Hold the Investment?
If the investment property is held for 5 years, the basis is increased by 10 percent of the amount of gain that would have been recognized; if the qualified investment is held for 7 years, then the basis is increased by another 5 percent of the amount of gain that would have been recognized. A special rule applies for investments held for at least 10 years to encourage long-term investment versus short-term speculation. If the investment is held for at least 10 years, then the basis of the investment is increased to the fair market value of the investment on the date of sale or exchange. The essentially means that if you hold the investment for at least 10 years, there is zero federal capital gains tax.
Where is the Opportunity?
In March 2018, state governors made nominations to the Secretary of the Treasury on which census tracts within their jurisdictions are considered low income communities and should be eligible as a Qualified Opportunity Zone (QOZ). “The Governor can designate up to 25 percent of census tracts that either have poverty rates of at least 20 percent or median family incomes of no more than 80 percent of statewide or metropolitan area family income.” Visit your own state’s website to view an interactive maps on areas your governor has identified as QOZ.
Not All Investments Are Good Investments
A tax incentive alone should not convince you to buy an asset, the investment should have good long-term growth prospects. For example, don’t buy an investment you believe will not increase in value just because you want to avoid capital gains in 10 years: if an investment does not grow, you will not owe capital gains tax anyway. Also, the introduction of the Opportunity Zone has given rise to so-called funds that will invest your money in these Qualified Opportunity Funds. Make sure to do your due diligence prior to investing money in such funds by fully understanding the underlying investments, structure, and fees involved.
Ara Oghoorian, CFA, CFP®, CPA is the President & Founder of ACap Asset Management & ACap Accounting Services.
ACap Advisors & Accountants is a “Fee-Only” wealth management and full-service accounting firm headquartered in Los Angeles, CA specializing in helping doctors and healthcare professionals make sound financial decisions.
Contact ACap at info@acapam.com or 818-272-8511.
