Opportunity Zones: A Tax Strategy for Capital Gains
- Posted: February 10, 2019
- Posted by: Travis Lynk
- Last Reviewed: February 27, 2019
Serious investors understand that geopolitical turmoil can have serious implications for a stock portfolio. In 2019, it is expected that many investors will make portfolio changes to minimize risk.
Selling assets at a profit, however, leaves investors with capital gains tax liability, which can be as high as 20% for long-term gains and 37% for short-term gains.
Without a tax strategy in place to minimize capital gains tax liability, taxpayers can lose a significant portion of profit in tax payments to the IRS. But the new Opportunity Zone program can help reduce that tax liability.
What is the Opportunity Zone program?
Before Congress created the Opportunity Zone program in the 2017 Tax Cuts and Jobs Act, investors essentially had three options for protecting capital gains: tax loss harvesting elsewhere in the portfolio to offset gains, charitable donations, and passing it on to heirs.
The Opportunity Zone program aims to stimulate private investment and development in economically distressed areas through the use of capital gains tax incentives. These incentives increase over time, favoring long-term investment to benefit low-income communities.
Under the new program, taxpayers roll untaxed capital gains into Qualified Opportunity Funds, which in turn invest the money in Opportunity Zone property. The investments can be in the form of partnership interests or stock ownership in a new or existing business located within an Opportunity Zone, or through the development of real property in one or more Opportunity Zones.
The incentives are significant. Taxpayers who invest capital gains in a Qualified Opportunity Fund defer capital gains taxes until December 31, 2026, or until the asset is sold, whichever comes first. Investments held for five years qualify for a 10% reduction in capital gains tax liability; after seven years, the reduction increases to 15%. If the assets are held for 10 years or more, investors pay no capital gains tax on Qualified Opportunity Fund investments.
To qualify for these tax benefits, investors must roll over gains into a Qualified Opportunity Fund within 180 days of the date gains are realized. Partnerships have flexibility under the program that further enhances capital gains tax strategy. A partnership may invest gains within the 180-day window that begins when gains are realized, or it may pass those gains along to individual partners. Partners have the option of using the 180-day window beginning on the date the gains were realized, or they can use the 180-day period beginning on the last day of the partnership’s tax year.
|Qualified Opportunity Fund Investment||Stock Portfolio|
|Realized Capital Gain in 2018||$1,000,000||$1,000,000|
|Gains Invested after Capital Gains Tax||$1,000,000||$800,000 (after 20% capital gains tax)|
|Average Annual Rate of Return||8%||8%|
|Value in 2026||$1,713,000||$1,371,000|
|Deferred Capital Gains Tax||$165,000||$0|
|Value in 2028||$1,958,000||$1,727,000|
|Capital Gains Tax on Sale of Investment||$0||$345,000 (after 20% capital gains tax)|
In the example outlined above, an investor who rolled untaxed capital gains into a Qualified Opportunity Fund would have nearly $600,000 more after 10 years than an investor who rolled gains into a traditional stock portfolio.