Add one more item to your holiday to-do list this year: “Invest my capital gains in a Qualified Opportunity Zone Fund.” A big deadline for potential Opportunity Zone investors will arrive on Dec. 31. To find out what investors need to know about that cutoff date and others, we enlisted the help of Steve Polivy, chair of Akerman LLP’s Economic Development and Incentives Practice.
The deadline to receive the full benefit of the program is Dec. 31, 2019.
Investors are able to defer and reduce capital gains tax when they invest their gains in a Qualified Opportunity Zone Fund that invests in real estate or businesses within an Opportunity Zone. If that investment has been in place for seven years prior to Dec. 31, 2026, then the basis for that capital gain is reduced by 15 percent and the amount of capital gain that would be due is reduced by 15 percent, according to Polivy.
“If an investor had a $1 million gain and they invest that $1 million gain in a Qualified Opportunity Zone fund prior to Dec. 31, 2019, and the fund then deploys the money as it’s required to—and that investment is held until Dec. 31, 2026—the tax due would only be due on $850,000 of the original $1 million investment,” he said.
In all cases, capital gains can only be deferred until Dec. 31, 2026.
Investors who miss the Dec. 31 deadline can still reap benefits from the program. A $1 million investment made in 2020 would receive a 10 percent reduction in capital gains tax. Thus, on Dec. 31, 2026, the investor would pay capital gains rates on $900,000.
“If you miss the seven-year window, then as long as the money has been invested for five years, it would be taxed at 90 percent of the basis,” said Polivy. “So, therefore, it would be a 10 percent reduction in the capital gain. And, if it’s less than five years, then it’s just an interest-free deferral of the capital gain until Dec. 31, 2026.”
The real bonus comes after a 10-year hold.
But regardless of when the QOZ fund investment is made, Polivy finds that the real incentive for those considering Opportunity Zone Fund investments is the benefit triggered after an investment is held for 10 years.
“Then, in essence, all of the appreciation in that investment can be sold tax-free because there’s a step-up in basis to fair market value if the investment has been held for a 10-year period,” he said.
Polivy offered this example: Suppose an investor has a $1 million gain and invests it in a QOZ fund prior to Dec. 31, 2019. If the fund deploys the capital as required and the investment is held until Dec. 31, 2026, it would incur capital gains tax on only $850,000 of the original $1 million. But if the gain were invested in 2020 instead of 2019, the tax reduction would be 10 percent rather than 15 percent. So on Dec. 31, 2026, the $900,000 gain would be taxable at capital gains rates.
However, let’s consider a different situation. If that same $1 million investment appreciates in value, and the property is sold after 10 years (at any time before Dec. 31, 2047), then any appreciation—for example, if the original $1 million investment is sold for $2 million—that $2 million is now a tax-free gain.
Don’t expect the Dec. 31 deadline to be extended.
Investors and advisers feeling cautious about Opportunity Zone investing are still waiting for further clarification from the IRS, and others are hoping that Congress, which sets the rules for Opportunity Zones, will extend the Dec. 31 deadline. That seems unlikely at this point, however. In fact, two bills in Congress would put additional limits on Opportunity Zones. One would stiffen the current minimal reporting requirements for Qualified Opportunity Zone Funds, and the other would reduce the number of Opportunity Zones on the grounds that some may be less needy than purported.
Investors should focus on deals, not deadlines.
While Polivy said there is an increased interest in the program, he does not see investors rushing to make deals they wouldn’t make otherwise if the tax incentives were not offered, particularly when there is a mismatch between developer and investor expectations for returns.
“The developer’s perspective is the investor has the built-in enhancement of the Qualifed Opportunity Zone Fund treatment,” he said. “The investor’s perspective is that they are making an investment in a low-income community, which by definition has some risk associated with it and, therefore, they want to see that they have the appropriate return to make that risk investment worthwhile.”