Taxpayers investing in economically distressed areas of the country may be eligible for a tax break if they act before the end of the year.
The Tax Cuts and Jobs Act (TCJA) created an opportunity for investors to defer taxes if they invest the capital gain amount in so-called “opportunity zones.” The TCJA established certain geographic areas in urban and rural communities that are economically distressed as opportunity zones. The program encourages investment in these areas to build businesses and create jobs.
With this program, taxes are deferred on the invested capital gain through the end of 2026, provided the taxpayer holds on to the investment. At that point, the amount of the original gain subject to tax would be reduced. The tax break is 10% if the investment is held for a five-year period.
Dates to monitor
To take advantage of the program, the next deadline for investors is December 31, 2021. To benefit from a 10% exclusion on capital gains, investors need to have invested in a qualified opportunity zone (QOZ) for five years (period ends 12/31/26).
A taxpayer can defer recognition of the gain until the earlier of (1) the sale or exchange of the taxpayer’s interest in the qualified opportunity fund, or (2) December 31, 2026.
While investments can be made into QOZ until December 31, 2026, the end of 2021 is the deadline for an investment to be held for five years as of December 31, 2026, and therefore qualify for a 10% basis step-up and related capital gain exclusion.
Requirements for investors
- The qualified capital gain, within 180 days of sale or exchange, must be invested in a qualified opportunity fund (QOF)
- Eligible taxpayers include individuals as well as corporations, partnerships, real estate investment trusts (REITs), regulated investment companies (RICs), and other pass-through entities
- Investment in a QOF must be equity interest and cannot be a debt instrument
- Funds must meet certain tests on percentage of assets invested within an opportunity zone
There are more than 8,700 designated opportunity zones across the country. The zones retain this status for 10 years.
Tax planning strategy
Taxpayers have seen an increase in overall prices this year, leading to higher capital gains tax exposure for some. Taking advantage of the opportunity zone program is one way that taxpayers may be able to mitigate capital gains taxes.
Taxpayers should consider how long they plan to hold the investment to benefit from excluding some of the capital gain from taxation. They must also consider any investment risk associated with investing in an underdeveloped area. Researching the community and its potential for a successful redevelopment is key. It is also important to discuss this tax strategy with a professional financial advisor and tax and legal experts who can weigh the benefits and risks.
For more details on qualified opportunity zones visit the IRS website.
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