Despite generating considerable debate and controversy, the Tax Cuts and Job Act (TCJA), which was touted as being the most comprehensive tax reform law in decades, was signed into law by President Donald Trump on December 22, 2017. While most taxpayers, pundits, and politicians focused on aspects of the law such as corporate tax cuts, revisions to income tax brackets, expansion of the standard deduction, and the repeal of the Obamacare individual mandate, another component of the reforms went largely unnoticed: a provision establishing nationwide “Opportunity Zones,” economically distressed regions in which financiers, venture capitalists, and other taxpayers are encouraged to invest by various tax incentives, including the ability to temporarily defer (or in some cases, permanently exclude) eligible gains. This component of the TCJA could prove to be a promising opportunity not only for communities that are struggling economically but also, for interested investors.
Taxpayers Who Invest in Opportunity Zones Can Defer Capital Gains Taxes
On February 8, 2018, the U.S. Department of the Treasury issued a press release announcing that, together with the Internal Revenue Service (IRS), the Department “provided guidance to states, the District of Columbia, and any possession of the United States, on designating Opportunity Zones.” (According to a statement by the California Department of Finance, “There are 3,516 census tracts in… California… that would qualify… allowing the Governor to designate up to 879 tracts.” Various maps of the nominated Opportunity Zone tracts can be viewed here.)
The idea behind the program is for taxpayers to reinvest gains from previously-made investments into “Qualified Opportunity Funds,” which will be used to help expand existing businesses, provide funding for new businesses, and/or fund real estate developments. If successful, the Opportunity Zones will benefit from economic reinvigoration, while investors will enjoy several benefits of their own.
Specifically, these benefits are that taxpayers can temporarily defer (delay) tax on eligible gains until either of the following occurs, whichever is earlier: disposition of the investment, or December 31, 2026, at which point the investor must pay tax on either (1) the gain deferred, or (2) the difference between the investment’s fair market value, minus the basis – whichever is the lesser amount. If the investment is held for a period of 10 years or longer, the taxpayer may permanently exclude eligible gains realized from exchanging or selling the investment from his or her taxable income. (Meanwhile, on the subject of deferring capital gains taxes, our readers might also be interested in learning about whether 1031 exchanges apply to Bitcoin.)
Additionally, taxpayers can benefit from a step-up in basis when they reinvest gains into a Qualified Opportunity Fund, depending on how long the investor holds the investment, as follows:
- If held for a minimum of five years, the basis increases by 10%.
- If held for a minimum of at least seven years, the basis increases by another 5%.
Therefore, if the taxpayer holds his or her investment for seven years or longer, as much as 15% of the gains realized can be excluded from his or her taxable income. These percentages are set forth under Section 1400Z-2 (Special Rules for Capital Gains Invested in Opportunity Zones). To view the new regulations concerning Opportunity Zones in full, interested readers should navigate to page 130 of the text of the tax law. The regulations, which continue through page 135, are set forth under Subchapter Z – Opportunity Zones. For an IRS overview of the regulations, the Department of the Treasury is referring taxpayers to 26 CFR 601.601: Rules and regulations.
Ask Our Attorney-CPAs About Tax-Efficient Investing Strategies
As any experienced investor knows, it is unwise to make an investment without thoroughly considering both the short-term and long-term tax implications. A prudent individual will take steps to research and develop a sound investment strategy with the appropriate level of risk – so why undermine that effort by then failing to account for the potential tax repercussions?
If you are considering investing in an Opportunity Zone – or, for that matter, any other investment opportunity, such as an Initial Coin Offering (ICO) or controlled foreign corporation – do not forget about the IRS: be sure to first review the potential tax consequences with an experienced tax attorney for nuanced and meticulous tax planning guidance. To arrange a reduced-rate consultation, contact the Tax Law Office of David W. Klasing online, or call (800) 681-1295 today.
Also, we’ve expanded our offices! In addition to our offices in Irvine and Los Angeles, the Tax Law Offices of David W. Klasing now have offices in San Bernardino, Santa Barbara, Panorama City, and Oxnard! You can find information on all of our offices here.
