Congress passed the Tax Cuts and Jobs Act, or TCJA to stimulate investment into economically troubled areas and low-income neighborhoods across the United States. The very first Opportunity Zones were established in San Antonio, Texas. This legislation identifies how capital gains can be deferred and reduced when invested in Qualified Opportunity Zones.
The capital gains tax incentives give Opportunity Zone Funds the potential to earn investors much better returns than with traditional investments- especially if you are in it for the long haul, for ten or more years. The ability to defer and use your capital gains to grow your portfolio is desirable, and investing in up and coming markets may bear its own rewards.
Opportunity Zone Funds:
Opportunity Zone Funds are investment vehicles that invest ninety percent or more of its holdings into real property, businesses, trusts, or partnerships within a qualified Opportunity Zone. The capital investments into designated Opportunity Zones give investors the ability to save investment capital in the short-term as well as pay the federal government less money from their long-term returns.
When an investor sells an asset that has appreciated in value such as ownership in a company, real estate, and other investment vehicles; they realize a capital gain (profit) and for tax purposes, this triggers a tax liability that the investor must pay to the IRS. However, similar to doing a 1031 exchange, investors may reinvest capital gains into an Opportunity Zone Fund and defer this taxable event. By doing so you now have more capital working for you than you would have if you paid the tax on your capital gain, and this can lead to greater return on your investment.
When you move realized capital gains into a designated Opportunity Zone Fund within a 180 day period of the asset sale you can defer paying any capital gains taxes until Dec 31, 2026, or when you sell your investment, whichever comes first. Delaying your tax liability gives you the ability to put more capital into play for an extended period. Instead of paying taxes, you can invest that money into new projects to earn increased returns.
If you hold your Opportunity Zone Fund investment for a five year period prior to Dec 31, 2026, you can reduce your capital gains tax liability by ten percent via a step-up in basis. If you extend your holding period by another two years you can reduce your deferred capital gains liability by an additional five percent. Holding an Opportunity Zone Fund investment for seven years before the December 2026 end date can allow you to reduce your tax liability on deferred capital gains by a total of fifteen percent.
Holding your Opportunity Zone Fund investment for an additional three years past the end date, for a total of ten years, will reduce your capital gains taxes or any appreciation from your original Opportunity Zone Fund investment to zero. This zero dollar tax bill is due to the fact that Opportunity Zone Funds gains qualify for permanent exclusion from capital gains taxes as long as you hold the investment for ten years.
If you’re looking to stay invested for the long haul the Opportunity Zone investment opportunities enable investors to achieve very good returns through the leverage and use of capital that would otherwise be taxable both before and after your investment. The ability to defer and use your capital gains to grow your portfolio can be a very powerful tool to grow your net worth and the value of your real estate portfolio.