TO KEEP YOU INFORMED
WHY THE NEW OPPORTUNITY ZONES COULD BE A REAL OPPORTUNITY FOR ENTREPRENEURS
HOW YOU CAN DEFER OR IN SOME CASES PERMANENTLY EXCLUDE GAINS FROM TAXABLE INCOME
July 19, 2018
I often get asked the question “If I roll over my investment, I don’t have to pay tax. Right?”, and up until now, I’ve had to answer “It just doesn’t work that way”. It’s never the answer that my clients want to hear. Now, however, I can say “Well have you heard about the new Opportunity Zone Funds?”. You can imagine that being able to defer or even permanently exclude some gains from tax is something that many entrepreneurs are really interested in. So how can you take advantage of this new opportunity?
The basic premise is that if you take gains that you have already realized and roll them in to Opportunity Funds that invest in eligible property, in a specifically designated Opportunity Zone, you can defer paying tax on the gain. The tax is deferred until the earlier of the date the investment is sold or exchanged, or December 31, 2026. If you stay invested in the Opportunity Fund for five years, you get an increase in your basis of 10% of the deferred gain; if you stay invested for an additional 2 years, you get an additional increase of 5%, thus excluding 15% of your original gain from tax. If the investment has not been sold by December 31, 2026, you have to recognize and pay tax on the net deferred gain at that time, but if you continue to hold your investment in the Opportunity Fund after that date, for at least a total of ten years, you get to step up your basis in the investment to the fair market value of the investment on the date the investment is sold or exchanged. This means that if you take full advantage of the provisions, only 85% of your original gain is taxed, and you are not taxed on any appreciation on your investment in the Opportunity Fund. Yes – you did read that correctly. If you hold your investment in the Opportunity Fund for at least ten years, you are eligible to increase your basis in the investment up to the fair market value of the investment on the date the investment is sold or exchanged.
Of course it is never quite as easy as it sounds. There are always, timeframes to meet, elections to be made, eligibility requirements and holding periods to be met that can make this quite complex, but the basic steps are quite simple.
If you have a gain from the sale or exchange of any property you must roll over the gain within 180 days into a qualified Opportunity Fund, which must then use the cash to purchase qualified property in an Opportunity Zone. There are some caveats: the sale or exchange must have been with an unrelated party and both the fund and the property will need to be certified as being eligible. But unlike a like kind exchange, only the gain and not the entire proceeds need to be rolled over, and if only part of the gain is rolled over the remainder is taxed. There is also no limit to the amount of gain that can be rolled over into an Opportunity Fund. One of the areas of clarification needed is whether the eligible gains are limited to just capital gains.
The idea behind this tax break is to spur investment into low income communities. Governors had to nominate communities as Qualified Opportunity Zones and the Secretary of the Treasury then certified the areas. Each Qualified Opportunity Zone retains the designation for ten years after certification.
Qualified Opportunity Funds can be set up as a corporation or a partnership, and must hold at least 90% of their assets in Qualified Opportunity Zone Property. There is a self-certification process for Qualified Opportunity Funds, which means that the taxpayer just completes a yet-to-be released form, and no approval by the IRS is required.
Qualified Opportunity Zone Property can be Qualified Opportunity Zone Stock, Qualified Opportunity Zone Partnership Interests, or Qualified Opportunity Zone Business Property. Each one of these designations has specific requirements, which means there are plenty of traps for the unwary. There is also clarification needed by the IRS in many areas, so this is still a developing area.
Is there risk associated with these? Of course! There is risk associated with any investment, and in this case the qualifying property has to be located in low income communities. The need for capital investment in these areas is large, and projects may be difficult to get off the ground. However, in my experience, entrepreneurs are not afraid of taking risks especially when there are tax advantages to be had. This is also not a strategy that you need to develop on your own. We are already starting to see that there is significant interest in the financial community for developing these as investment products, and incentive for leaders in these communities to put forward projects. I would expect to see products become available later in the year as the details, risks and opportunities become clearer.
Here is my advice if you are interested in seeing if this opportunity is one that you can’t pass up:
- Get good advice. Although the basic premise is simple, as with many other tax opportunities, the devil is in the details. There are many potential pitfalls and each step needs to be analyzed to make sure the appropriate qualifications and certifications are in place.
- Don’t delay. If you have potential gains that you want to defer, you only have 180 days to roll them over. Don’t wait until the last minute to take action; haste does not typically make for good decision making.
- Do your research. Whether you are looking at Qualified Opportunity Zone Stock, Qualified Opportunity Zone Partnership Interests, or Qualified Opportunity Zone Business Property, don’t make a poor investment decision just because there are tax savings to be had. As we often say, don’t let the tax tail wag the dog.
- Don’t be afraid. Although there are still some details to be clarified, this is a valid tax saving opportunity.
We developed our Entrepreneurial Excellence program specifically for people facing these situations. This program allows our team members to take a comprehensive look at your goals, your situation and the challenges you are facing. If you want to take advantage of the tax breaks that Opportunity Zone Funds can deliver, I recommend that you take a look at our program.
Nicola Neilon – CPA, SHAREHOLDER
I am a CPA and shareholder at Casey Neilon. In this role, I work with many small businesses and their owners. I love that this gives me the opportunity to go beyond just being a tax preparer or auditor. The long-term relationship that develops encompasses the roles of business advisor and trusted confidant. I have been serving clients in this capacity since 1997. My experiences have taught me that I am not Wonder Woman, nor do I have a crystal ball, but many people have no background in accounting and finance, and they need someone that they can trust to help them navigate a path to reach their goals.