The 2017 Tax Cuts and Jobs Act (TCJA) included a new tax incentive intended to spur investment in low-income areas throughout the country by offering capital gain deferral and reduced tax on qualified Opportunity Zone investments. There are currently over 8,700 low-income census tracts designated as “Opportunity Zones” throughout the United States that were identified by each state government. These new Opportunity Zones are different than past Empowerment Zones and New York State Empire Zones. A map of the zones can be viewed here.
In order to encourage investment into these zones, the new law allows capital gains that are reinvested into a “Qualified Opportunity Fund” (QOF) to be deferred until the earlier of the disposition of the QOF investment or December 31, 2026. As an added bonus, if the QOF investment is held for at least 5 years, the amount of the previously deferred gain that must be recognized is reduced by 10%. The exclusion increases to 15% for deferrals of 7 years or more. Because all deferred gains must be recognized if the QOF is still held on December 31, 2026, investors aiming for the 15% exclusion will need to make their QOF investments by the end of 2019. To further sweeten the incentive and encourage long-term investments, if the QOF investment is held for at least 10 years, any capital gain on the appreciation of the investment is excluded from income when sold. New York State follows the federal rules, so the eligible gains will also be deferred or excluded for New York tax.
Any capital gains on sales to unrelated parties that would be reported on the current year tax return are eligible for this deferral. An investment is required to be made into a QOF within 180 days of the gain, and taxpayers must make an election on their return to report the deferral.
Example: A taxpayer sells stock with a resulting capital gain of $10,000 on 7/1/2019. Within 180 days, he invests the $10,000 into a QOF and does not recognize any of the $10,000 capital gain on his 2019 tax return. Assuming he still holds the QOF on 12/31/2026, he will have held the investment for more than 7 years and qualifies for the 15% gain exclusion. The taxpayer will recognize $8,500 ($10,000 * 85%) of capital gains on his 2026 tax return. If he sells his investment in the QOF on 4/1/2030 (more than 10 years from initial investment) for $20,000, he will pay no capital gains tax on the appreciation of the investment. Participating in the Opportunity Zones program allows him to forego ever recognizing $11,500 of gain.
Qualifying Capital Gain Deferral
In order to qualify for deferral, the amount invested into the fund must come directly from a capital gain. You do not need to invest the entire capital gain, but only the amount of gain invested into the QOF is eligible for the preferential treatment. You may also invest more than the amount of the deferred capital gain into the QOF, but only the amount of deferred capital gain is eligible for the tax benefits. A QOF may also receive investments from individuals who do not have any capital gains to defer; they may be owners or partners in the QOF, however they will not receive any gain exclusion when the investment is sold. For instance in the above example, if the proceeds from the original sale of stock were $30,000 and the stock’s basis was $20,000 (gain of $10,000) and the entire $30,000 was invested into a QOF, the investment would be separately tracked – splitting the $10,000 deferred gain and the $20,000 original return of capital. The taxpayer would fully recognize any gain resulting from appreciation on the $20,000 portion when the QOF is ultimately sold; even if the QOF is held for more than 10 years.
To be a Qualified Opportunity Fund, the corporation or partnership must have at least 90% of its assets invested within Opportunity Zones. This includes investment in stock or partnership interest of Opportunity Zone businesses, or investments in business property within the zones. The entity must certify each year that they meet the 90% requirement. Additionally, many traditional stock brokers have already established Qualified Opportunity Zone Funds. Contact your Bonadio team member to further discuss investing in an Opportunity Zone to take advantage of these tax savings.
Matt Dabrowski is an assistant accountant based out of our Syracuse, NY office.
Kristin Hohn is a senior accountant based out of our Syracuse, NY office.