19 Jun Are Qualified Opportunity Zones Right For You?
I recently attended a 2-hour webinar on the topic of Qualified Opportunity Zones and want to share my takeaways and thoughts. The webinar got into the weeds of the rules to become a Qualified Opportunity Zone Business as well as the tax benefits to the investors in these businesses. I’m going to focus on the investor point of view rather than running a business trying to qualify. For purposes of this article, we will assume the people running the business and their tax advisors are on top of it. A big assumption I know, but more than I want to cover.
I’m not a fan of investing in something just because it’s tax favored, aside from retirement accounts. I’m talking about oil and gas investments, syndicated conservation easements, and even municipal bonds. Taxes are just one variable but we should keep in mind that it’s best to maximize your after-tax wealth, not just to pay the least amount in taxes. A non-tax favored investment might produce a better after-tax return.
With those disclaimers out of the way, let’s dive into Qualified Opportunity Zones. At the end of 2017, Congress passed the Tax Cuts & Jobs Act. In that act they created this new provision that allowed investors in businesses operating in certain areas, Opportunity Zones, to defer, reduce, and even eliminate income from capital gains.
If you sell property and have capital gain, you can defer recognizing the capital gain as income if you invest some or all of the gain amount into a Qualified Opportunity Fund (QOF). This deferral gives you more money to invest because you’re not paying taxes on all of the gain.
You only need to invest the amount of your gain and not the entire sale proceeds. You can also invest less than the full amount of your gain but can only defer up to the amount you invest.
You have 180-days after the sale to invest in the QOF. If your gain comes from a partnership or S-corporation or is §1231 gain you can have 180 days from the end of your tax year to invest.
After five years of investment in the QOF, 10% of your deferred gain goes away and you get to step up your cost basis in the QOF.
Two years later, or seven years after your investment, you get to knock 5% more of the deferred gain off. This means that 15% of your total deferred gain is no longer taxable.
No matter when you invested in a QOF, any deferred gain must be recognized on your 2026 tax return.
If you hold your investment in the QOF for 10 years, you can sell it tax free.
To tie it all together, here’s a nice clean example of how this would work –
In June of 2019 you sell stock for $350,000 that you originally paid $300,000 for 6 years before. This produces a long-term capital gain of $50,000.
In July of 2019 you invest $100,000 into a Qualified Opportunity Zone Business that is taxed as a C-corporation. Your basis in the C-corporation stock is $50,000.
In February of 2020, you file your income tax return and report the $50,000 gain on Form 8949 but enter a negative adjustment on a separate line. This affirmatively elects to defer the gain.
In June of 2024, you get to step up your basis by $5,000, which is 10% of your originally deferred gain. Your basis is now $55,000.
In June of 2025, you get to step up your basis by $2,500, which is 5% of $50,000. Your basis is now $57,500.
On December 31, 2026 you must recognize all of the previously deferred gain less the 15% that gets permanently excluded. In our case this gain is $42,500 that must be reported on your 2026 income tax return filed in early 2027.
In June of 2029 you’ve now held your investment for 10 years. If you sell it for$125,000 you would recognize a gain of $25,000. This $25,000 gain is totally tax free.
Unless you’ve got some very large capital gains coming in or you have an investment you’re confident about, I personally don’t think investing in a QOF makes a lot of sense. There is a lot of complexity and unless there’s a substantial amount of tax at stake it doesn’t seem worth it.