The Tax Cuts & Jobs Act of 2017 (“TCJA”) makes December 31, 2019 (aka #NYE2020) the LAST date for investors to obtain the greatest tax benefit from investing in Opportunity Zones. According to the TCJA, investors can defer tax recognition of capital gains until 2026 if the investors invest in a qualified Opportunity Zone Fund or qualified Opportunity Zone Business Property within 180 days of the sale that triggered the capital gains.
For example, Smart Investor realizes $1 million capital gain in 2019 for the sale of a capital asset, such as stocks or property. If Smart Investor invests that $1 million in a qualified Opportunity Zone Fund, Opportunity Zone Property, or Opportunity Zone Business, Smart Investor’s capital gains tax, $200,000 at the 20% current capital gains tax rate, is deferred until after December 31, 2026, when this capital gain must be paid by Smart Investor in her tax 2027 tax filing. This benefit alone is significant since Smart Investor understands that the present value of money is generally greater than the future value. But as the infomercials love to state, “But wait, there’s more!”
If Smart Investor stays invested in the Opportunity Zone Fund for at least 5 years, Smart Investor gets (what’s affectionately called in tax circles) a 10% step-up in basis. Simply translated, the IRS will only recognize 90% of the capital gain, e.g. Smart Investor would only owe $180,000 in capital gains taxes after December 31, 2026. If Smart Investor stays invested for 7 years, the IRS will add a 5% step-up in basis; therefore Smart Investor would owe $170,000 in capital gains taxes, payable after December 31, 2026. Since TCJA only defers compliant elections for capital gains recognition until December 31, 2026, December 31, 2019 is the last date for an investor to maximize the entire 15% step-up in basis.
There’s an additional benefit of investing in Opportunity Zone investments: potential tax-free gain on the investment if it’s held for at least 10 years. Assuming Smart Investor held her $1 million investment in the Opportunity Zone for at least 10 years, and she sells this investment for $1,500,000 – a $500,000 capital gain on the Opportunity Zone investment. Smart Investor’s $500,000 gain would be tax-free. If Smart Investor realized a $1 million capital gain before the end of 2019, she would’ve netted $1,330,000 ($1,500,000 – $170,000 in capital gains taxes (paid in 2027)). If Smart Investor ‘s cousin, Not-So-Smart Investor, chose another investment that provided a similar return after 10 years, she would have netted $1,120,000 ($800,000 net in 2019 plus 1.5x over 10 years less 20% capital gains tax on the $400,000 gain). Smart Investor would obtain 33% net gain on her investment versus her cousin’s 12% net gain – nearly 3x by taking advantage of Opportunity Zone investments under the TCJA.
Since Opportunity Zone investments are fairly new, the Treasury Department has issued and continues to issue proposed regulations to help legal and accounting professionals navigate the new law. Therefore, it’s critical for investors, who are seeking to take advantage of this potential tax bonanza, to hire competent legal representation before investing. Nothing herein constitutes legal advice or accounting advice nor constitutes an attorney-client relationship between Burrell Law, P.C. and the reader.