This is a Thought Leadership article by PrimeGlobal member firm Carr, Riggs & Ingram which answers the question How Does an Investment in an Opportunity Zone Affect Your Taxes?
Investors and developers have many questions about the opportunity zone program created by the Tax Cuts and Jobs Act of 2017. The following example gives some specifics about how these investments will be structured.
An investor or developer has a qualifying gain of $1 million from the sale of a capital asset. She chooses to reinvest that $1 million into a qualified opportunity fund (QOF) on December 1, 2019. The QOF invests at least 90% of its assets into either a qualified opportunity zone (QOZ) business or a qualified opportunity zone business property (QOZBP) and continues to meet the QOF requirements for the life of the investment.
|QOZBP||Property that is acquired by purchase after December 31, 2017, where the original use of the property is within the opportunity zone.|
|QOZ business||Substantially all (at least 70%) of the tangible property owned or leased by the entity is QOZBP. At least 50% of the entity’s total gross income is derived from active trade or business. Rentals on triple-net basis do not qualify.|
Advantages of Five-Year Holding Period
Once the investor holds the investment for five years, the basis of the investment will increase by 10% of the capital gain deferred. In this example, the basis step-up is $100,000.
- On December 15, 2024, the investor sells the QOF shares for $2 million. The investor recognizes $1.9 million of capital gain from this transaction alone on her 2024 tax return. At current rates, that amounts to a $380,000 bill (20% × $1.9 million) that affects her balance due in April 2025. (Tax owed is considered due on the original due date without extension.)
- She saves $20,000 of tax on the basis increase, and she has the time value of the money held in the investment for the five-year period without taxes.
Advantages of Seven-Year Holding Period
If the investor chooses to hold on to the investment for seven years, the basis of the investment increases an additional 5 percentage points to a total of 15%.
- On December 15, 2026, the investor sells the fund shares for $2 million. The investor recognizes $1.85 million of capital gain from this transaction alone on her 2026 tax return. At current rates, that amounts to a $370,000 bill (20% × $1.85 million) that affects her balance due in April 2027.
- She saves $30,000 of tax on the basis increase, and she has the time value of the money held in the investment for the seven-year period without taxes.
Expiration on December 31, 2026
As currently on the books, these basis deferrals will cease to exist after December 31, 2026. So in order to meet the seven-year holding requirement and take advantage of the full 15% deferral, an investor needs to have her existing capital gain reinvested into the QOF, QOZ business, or QOZBP before December 31, 2019.
In addition, this expiration means that the investor will recognize whatever capital gain has been deferred to date at that time. So even if the investor does not sell her shares in the QOF, she still has a capital gain transaction dated December 31 on her tax return for 2026.
If she meets either the five-year or seven-year holding requirements described above, those gain scenarios apply only to her original deferred capital gain of $1 million.
|7 Years||(based on this transaction alone) $170,000||20% × $0.85 million basis|
|5 Years||(based on this transaction alone) $180,000||20% × $0.9 million basis|
|< 5 Years||$200,000||20% × the basis of the original gain, $1 million|
These amounts would be due on the same timeline as described above.
Advantages of Holding 10 Years and Beyond
- While the opportunity zone capital gain deferral ends on December 31, 2026, there are additional benefits available to investors who make a “fair market value” step-up basis election and hold on to their QOF shares for at least ten years.
- Say that our investor pays the taxes associated with whichever holding period applies on December 31, 2026. She then sells her QOF shares for $3 million on June 30, 2030. For her 2030 tax return, she shows the basis of her QOF shares as their fair market value on the date of the sale and has a net of $0 additional capital gain.
Individual Situations Vary
This example makes a lot of assumptions. Remember:
- The discussion is based on current law, which is subject to change.
- Although the intent of the law is to increase the value of QOF shares, QOZ businesses, and QOZBP by drawing more investment and jobs into the zones, the law cannot guarantee that these assets will appreciate.
As always, your individual circumstances are the most important thing to consider. If you think you may be in a position to benefit from an opportunity zone investment, please contact your CRI tax professional for a consultation.
Carr, Riggs & Ingram, LLC
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