Key takeaways:
What this may mean for you:
An Opportunity Zone is a community nominated by the state and certified by the Treasury Department as qualifying for this program. The Treasury Department has certified zones in all 50 states, Washington, D.C., and U.S. territories.
There are approximately 8,700 Opportunity Zones nationwide. A list can be found at the U.S. Department of the Treasury, Community Development Financial Institutions Fund.
To defer a capital gain (including “net” §1231 gains), a taxpayer has 180 days from the date of the sale or exchange of appreciated property to invest the realized capital gain dollars into a Qualified Opportunity Zone Fund. The fund then invests in Qualified Opportunity Zone Property.
The taxpayer may invest the return of principal as well as the recognized capital gain, but only the portion of the investment attributable to the capital gain will be eligible for the exemption from tax on further appreciation of the Opportunity Zone Investment, as explained below. The Opportunity Zone program allows for the sale of any appreciated assets, such as stock, with a reinvestment of the gain into an Opportunity Zone Fund. There is no requirement to invest in a like-kind property to defer the gain.
Note that a taxpayer who receives a reported capital gain from a flow-through entity, such as a partnership, S-corporation, or a trust/estate, has 180 days from the end of the calendar year to make an investment in a Qualified Opportunity Zone Fund, regardless of how early in the calendar year the entity itself realized its gain. For example, if a partnership entity realized a capital gain in March, each partner’s 180-day triggering date will be December 31 of the same year and each partner will have until approximately June 28 of the following year to make their Qualified Opportunity Zone investment.
A Qualified Opportunity Zone Fund is any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified opportunity zone property (other than another qualified opportunity fund) that holds at least 90 percent of its assets in qualified opportunity zone property.
Similar to other investments, an investment in an Opportunity Zone Fund may increase or decrease in value over the holding period. In addition, income may be paid on this investment. Given that the purpose of the program is to improve particular areas, it is expected that the fund will continue to invest in the improvement of the property in which it is invested. Cash flow may occur once the property improvements are complete and the property is leased or sold to third parties.
Since Qualified Opportunity Zone Funds are new income tax planning tools and are new investment options for taxpayers, these investments may involve risk. Like many other types of investments, the risks may potentially include market loss, liquidity risk, and business risk to name just a few. Because this investment may not be appropriate for all investors, consult with your tax advisor before pursuing such an investment to determine if this fits with your risk profile and diversification of your investments.
Qualified Opportunity Zone Property is used to refer to property that is qualified opportunity zone stock, a qualified opportunity zone partnership interest or a qualified opportunity zone business property acquired after December 31, 2017, used in a trade or business conducted in a Qualified Opportunity Zone or ownership interest in an entity (stock and partnership interests) operating with such tangible property.
Conceptually, the Opportunity Zone Fund must bring property new to the entity to be used in the Opportunity Zone. A fund that simply acquires property already being used in the zone will not qualify without substantial improvement. Substantial improvement requires improvements equal to the Opportunity Zone Fund’s initial investment into the existing property over a 30-month period.
For instance, if an Opportunity Zone Fund acquires existing real property in an Opportunity Zone for $1 million, the fund has 30 months to invest an additional $1 million for improvements to that property in order to qualify for this program. Certain businesses such as golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, race tracks or other facilities used for gambling, or liquor stores are prohibited for Opportunity Zone Fund investments.
An Opportunity Zone Fund investment provides potential tax savings in three ways:
Tax deferral through 2026 - A taxpayer may elect to defer the tax on some or all of a capital gain if, during the 180 day period beginning at the date of sale/exchange, they invest in a qualified opportunity fund. Any taxable gain invested in an Opportunity Zone Fund is not recognized until December 31, 2026, (due with the filing of the 2026 return in 2027) or until the interest in the fund is sold or exchanged, whichever occurs first. In addition, the deferred gain can be further reduced as described below.
Step up in tax basis of 10% or up to 15% of deferred gains - A taxpayer who defers gains through an Opportunity Zone Fund investment receives a 10% step-up in tax basis after five years and additional 5% step-up after seven years. Note that to take full advantage of the 15% step-up in tax basis, the taxpayer must have invested by December 31, 2019. When the tax is triggered at the end of 2026, the taxpayer will have held the investment in the fund for seven years, thereby qualifying for the 15% increase in tax basis.
No tax on appreciation - Remaining in the qualified opportunity fund for at least ten years results in the cost basis of the property being equal to the fair market value on the date of sale/exchange (potential to lower cost basis but does not eliminate the gain recognition event on 12/31/2026).
Wells Fargo Bank will be publishing companion article(s) which will provide a more in-depth analysis of the operation of Qualified Opportunity Zone funds and how taxpayers may navigate this new topic.
Since the introduction of this new law at the end of 2017, the Internal Revenue Service has issued “Treasury Regulations” which help taxpayers and their professional advisors better understand some of the detailed nuances of this program, and these regulations have settled some of the uneasy questions that surrounded the program in its early stages. Taxpayers should definitely seek the advice their professional legal and tax counselors when considering a Qualified Opportunity Zone Investment.
Authors: Aaron Waites, Regional Wealth Planning Manager; Jason Walker, Senior Wealth Planning Strategist; Jennifer Proper, Senior Wealth Planning Strategist, Abbot Downing
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Wells Fargo & Company and its affiliates do not provide legal advice. Please consult your legal and/or tax advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed. CAR-0520-02850