by Mark Underhill, CPA

What if I told you that you could defer your capital gains on the sale of an investment until potentially 2026 and exclude up to 15 percent of those gains from tax permanently? What if I said that you could also permanently exclude all future gains from your investment? You’d probably say that this sounds too good to be true. Fortunately for us all, this is a very real possibility thanks to the recent Tax Cuts and Jobs Act of 2017.

The Act created a new community revitalization program called Opportunity Zones. To capitalize on the benefits of this program, we must first understand what an Opportunity Zone is. These zones consist of 8,762 low-income census tracts across all 50 states, the District of Columbia, and five U.S. possessions. These zones were nominated by each state and then designated by the Treasury Department. As of June 14, 2018, all zones were officially designated by the Treasury Department and will retain their status until December 31, 2028. In Alabama, there are 158 designated opportunity zones with at least one Opportunity Zone in each of the state’s 67 counties. Many of the state’s major metropolitan areas are designated as Opportunity Zones including most of downtown Birmingham.

The Opportunity Zone program provides for three significant potential tax planning opportunities. The first allows taxpayers to defer recognition and thus the tax on the capital gains from the sale of any property until potentially December 31, 2026. To qualify, taxpayers must reinvest their gain, or a portion of it, into an Opportunity Zone Fund within 180 days of sale. One key item to note is that there is no requirement to invest all proceeds from the sale, only the portion that represents your gain. If your gain is invested into an Opportunity Zone Fund within 180 days, it can be deferred until either the date that you sell your investment in the Fund or December 31, 2026, whichever occurs first.

The second tax savings opportunity allows taxpayers to permanently exclude 10 percent of the capital gains that the taxpayer rolls into the Opportunity Fund if they hold their investment for at least five years. For taxpayers who hold their investment in the fund for at least seven years, this exclusion increases to 15 percent. This means that taxpayers investing capital gains into a qualified opportunity fund that they own for at least seven years will only pay 85 percent of the tax on their original gains, and they will not pay the tax until at least seven years after the gain was generated.

Last, but certainly not least, the program provides for the permanent exclusion of all gains associated with the post investment appreciation the taxpayer has in the Opportunity Fund if the taxpayer holds their investment at least 10 years. This could provide the biggest incentive for taxpayers who invest in these opportunity zones.

If you are anything like me, this may all sound good, but a real-world example always helps put things into perspective. Let’s say I have some property that I previously purchased for $5 million but sell it for $6 million in 2018 (I know I said real-world example, but let’s ignore my wishful thinking and just go with it). After the sale of this property, I would normally have to recognize my gain and pay the tax on those gains with my 2018 tax return. Rather than pay tax of potentially 28.8 percent (combined fed, state, and net investment income tax) on these gains I decide to roll that $1 million gain into a Qualified Opportunity Zone Fund and hold that investment for at least 10 years when the investment is now worth $3 million (again wishful thinking). In this scenario I capitalize on all three tax incentives of the Opportunity Zone program. By doing this, I’m able to delay paying tax on my original $1 million gain until 2026 and I have reduced that gain by 15 percent, or $150k, by holding that investment in the fund for more than seven years. Additionally, the $2 million of appreciation that my investment into the fund experienced over ten years is completely tax free.

BMSS will soon be releasing additional information on this exciting new program and the potential tax planning and investment opportunities that this program offers. If you would like more information please contact your BMSS tax professional or call us today at 1-833-CPA-BMSS.


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