You may have seen more news stories mentioning Opportunity Zones of late, but there are still plenty of questions surrounding this part of the latest tax reform. Today we're discussing the ins and outs of investing in Opportunity Zones to help you understand how, in the right circumstances, they could help you save thousands on your taxes. We’ll discuss what opportunity zones are, why they were created, what the tax benefits are and how to spot the risks involved when investing in opportunity zones.
The new tax law was created to spur economic investment in low-income areas throughout the U.S. by providing individual investors with tax incentives for investing in impoverished communities. The low-income areas are called opportunity zones and are identified by governors of each state. Although it was rolled out in 2017 it wasn’t until recently that the IRS updated investors on how the program is actually going to work. This program is geared toward long-term private investors with a high net worth. There are 3 benefits to the tax side of this law: tax deferral, tax reduction, and tax elimination for an investment held for more than 10 years. The primary purpose of the reform is to help economically distressed communities and in turn, it can help you save thousands in taxes. Find out how by listening to this episode of Financial Symmetry.
Under the new tax reform law, you can defer capital gain tax from the sale of real estate, a business, or stock. You can also reduce your taxes on something you recently sold and even completely eliminate taxes by reinvesting.
Here’s an example:
You sell something and earn a million in capital gain. Normally you would pay $240,000 in taxes on that capital gain. Now with the opportunity zones if you reinvest your capital gains into a qualified opportunity zone fund within 180 days you get to defer the capital gain tax on the million dollar sale. So instead of paying those $240,000 in taxes in 2019, you won’t have to pay that until 2026. Then in 2026 if you continue to hold that investment in the opportunity zone then you only pay tax on $850,000 of the million dollar original capital gain. So you’ll save about $36,000 there. But the biggest benefit overall for the program is that if you put that money into a new investment for 10 years or more you’ll pay no capital gains tax on the original investment.
To invest in opportunity zones and save on capital gains taxes you can invest in a qualified opportunity fund. A qualified opportunity fund is a corporation or partnership that is created for the purpose of investing in qualified opportunity zone property and holds at least 90% of its assets in qualified opportunity zones. The typical investment options are real estate, such as multi-unit apartment buildings, or a business located in a qualified opportunity zone.
You have to spend 100% of the purchase price in the first 30 months. So if you purchase a property for $800,000 then you have to spend another $800,000 within 30 months. The idea is that you are substantially improving the property for the amount that it is valued at. If you buy a business the same rules apply. You have to improve it somehow for that purchase amount. Remember, this is not an investment in the stock market, there is a higher degree of research involved.
There are different risks involved in taking advantage of the new tax reform law. As with all investing situations, attention to detail is key. Here are some of the risks with this type of investment.
Many people don’t take advantage of things because they don’t know about it. We’re here to give you ideas and strategies that you may not be aware of. The overall goal of the new tax law is a great cause but the investment options are still pretty new. This was just an overview of rules and regulations, so do your own research. Don’t let taxes decide your investment decisions. Remember a bad investment is still a bad investment no matter what the tax benefits are.