Capital Gains Taxes on Sale with Qualified Opportunity Zones
Imagine you have sold your business, highly appreciated stock, or other qualified assets that will trigger a large amount of capital gains tax. Most CPAs will say paying lots of tax means you made lots of money and that it’s a good problem to have. Or they might say something like, “you make what you make, you pay what you pay.”
For most Americans, after many years of hard work, sacrifice, risk, and delayed gratification, writing a check to the IRS, for what could be hundreds of thousands of dollars, might feel a bit uncomfortable especially when a high percentage of Americans have little trust or respect for the fiscal spending policies in Washington, DC.
Reduce Your Tax Liability
But what if there was an IRS-compliant way to significantly reduce your tax liability, while at the same time solving for the replacement investment, with the icing on the cake being that you are helping communities in need of economic revitalization?
2017 Tax Cuts and Jobs Act
That’s exactly what Democratic Senator Cory Booker and Republican Senator Tim Scott had in mind when they co-authored the legislation on Qualified Opportunity Zones that was enacted into law as part of the 2017 Tax Cuts and Jobs Act under President Trump.
Qualified Opportunity Zone Investing
Qualified Opportunity Zone investing and their associated tax abatements have sparked enthusiasm and support from both Democrats and Republicans which is rarer these days than the lunar eclipse.
In drafting the legislation, Congress enlisted the support of the Governors of all 50 states to name areas in each Governor’s state that could benefit from economic development and stimulus. In total, 8,741 census tract areas around the United States have been designated for investment and tax abatement.
Many of these areas are economically blighted and some are in high-crime areas. Some are simply more rural properties, while others are in areas that are already under economic redevelopment. See the map below for the designated Qualified Opportunity Zones in the United States.
Qualified Opportunity Zones Map
Defer and Reduce Taxes
In Qualified Opportunity Zones, investors are offered the chance to use their capital gains to invest in designated areas around the United States and defer taxes on their gains until the 2026 tax year, which would make taxes due in 2027.
Additionally, any investments made before year-end 2021 will receive a 10% reduction in the taxes that will be due in 2027.
100% Tax-Free Growth
Deferring taxes is almost always a good thing, but that’s not what has investors so interested in Qualified Opportunity Zones. What actually has investors lining up to invest in Qualified Opportunity Zones is the 100% tax-free growth on the investments if they are held for the required investment period of 10 years.
Attractive Tax Incentives
Today, many CPAs are attending conferences and learning about Qualified Opportunity Zones and the tax-favored treatment afforded them. The idea seems to be gaining momentum as The DI Wire website estimates over 29 billion dollars have flowed into QOZ funds, and that number is growing substantially each year as Americans are learning how attractive the tax incentives can be.
“But wait”, an investor might say…”
“If I am of the mindset that taxes are going up, wouldn’t I be better off to pay the taxes now rather than to defer them to 2026 or 2027?”
That’s a great question, one that CPAs are learning the answer to as noted in the calculations below.
Note that the column to the right assumes that taxes were to go up by 50%, which some would consider extreme. Even if taxes were to rise substantially, an investor could potentially still be in a much better position with a Qualified Opportunity Zone investment due to the effect of the tax deferral and the tax-free growth of the investment.
As noted in the calculator, an investor who benefited from the tax-favored treatment of a Qualified Opportunity Zone could potentially have almost 30% more net after-tax wealth versus paying the tax now and then paying taxes on all future growth in a non-Qualified Opportunity Zone investment.
Keep in mind, a taxpayer with a capital gain from a flow-through entity, like a partnership or S Corp, has 180 days from the end of the calendar year to make an investment in a QOZ, regardless of how early in the calendar year the entity realized the gain.
For example, if a partnership realized a gain in March, each partner’s 180-day date would be December 31 of the same year, and each partner will have until approximately June 28 of the following year to make a Qualified Opportunity Zone investment.
Another common question or objection that an investor might have is a concern that these investments could be in high-crime areas.
Many of the Qualified Opportunity Zones are in areas that most people would not be comfortable investing their hard-earned money, however, developers today are sorting through the opportunities zone areas and finding opportunities that are supported by the developers’ own due diligence and demographic requirements.
For example, Uber decided to move its world headquarters to Dallas, Texas in a Qualified Opportunity Zone. The development is estimated to bring 3,000 jobs to the area along with economic development of housing, retail, restaurants, and more.
Investors had the chance to invest in the Uber infrastructure and received substantial tax benefits along with long-term lease guarantees from Uber which many investors have found to be very attractive.
Types of Qualified Opportunity Zone Investments
Many Qualified Opportunity Zone investments are in Class A apartments, life science medical buildings, self-storage, multi-use development, and industrial buildings such as the properties shown below in a QOZ fund in Richmond, Virginia and Philadelphia, Pennsylvania.
Most credible real estate developers are of the mindset that tax incentives won’t make a bad real estate deal a good one, but tax benefits can make a good real estate deal great.
Why Qualified Opportunity Zones Are Growing
Herein lays the ethos of why Qualified Opportunity Zones are growing at such a rapid pace. Keep in mind that Qualified Opportunity Zone investments are offered only to Accredited Investors and only by Private Placement Memorandum.
Accredited Investors generally are required to have a net worth of over $1 million dollars apart from their primary residents, but there are other rules and exceptions that an investor should be aware of.
Due Diligence – Investors would be wise to find a Fiduciary Advisor who has resources and access to the required due diligence that any prudent investor would want before making an investment in a Qualified Opportunity Zone.
The due diligence should contain:
- A tax opinion letter from a credible law firm.
- Full financial disclosure on any debt, cash reserves, exit strategy, profits splits and other salient details pertinent to these types of investments.
- Moreover, most investors would best served to seek out developers in this space who have a long and well-documented track record of success.
A few notable players in the Qualified Opportunity Zone space include Cantor Fitzgerald, Inland Private Capital, Capital Square, Griffin Capital, Caliber, CIM Investment, and Urban Catalyst.
Qualified Tax Professional
Investing in real estate with tax incentives should be done with the advice of a qualified tax professional.
You can read more about the IRS code on Opportunity Zones HERE.