"The most valuable tax break ever"- FORBES
In the Tax Cuts and Jobs Act passed in late 2017, there is a provision within the bill that created an opportunity to invest directly in Real Estate and defer taxes you would otherwise be subjected to due to capital gains. They are called Qualified Opportunity Funds (QOF) and are described in IRC Sec. 1400Z-2
Investors have the potential to entirely eliminate the capital gains on real estate owned in opportunity zones. When you compare this to a 1031 Exchange, where you generally roll all the proceeds from the sale of the asset into the replacement fund, this provision allows investors to receive their basis upon liquidation of an asset, while only rolling their capital gains into the opportunity fund.
The Incentives include:
(1) Tax deferral of capital gain invested in a qualified opportunity fund
(2) Eliminating 15% of the capital gain that was invested in the fund from taxation
(3) Eliminating tax on gain generated by the fund itself.
Investors who invest in Qualified Opportunity Funds will receive a step-up in basis if they hold the investment for a certain number of years. Initially, the step-up is zero.
If the investor holds for five years, they will receive a basis step-up of 10%. If the investor holds for seven years, they will receive an additional 5% of basis step-up. As a result, if an investor holds a Qualified Opportunity Fund investment for a period of seven years or more, they will reduce the originally taxable portion of their capital gain by 15%.
ELIMINATING CAPITAL GAINS
If an investor holds their Qualified Opportunity Fund investment for a period of 10 years or more, the investor will not recognize capital gain on the appreciation of their investment during the hold period.
In October 2018, the Treasury released more clarity on proposed regulations:
• Taxpayers can invest more than just tax deferred capital gains into Qualified Opportunity Zones (QOZ), only investments made with tax-deferred proceeds or a tax deferred election will be eligible for the capital gains tax exclusion on gains from their QOF investment.
• Qualified Opportunity Zones will lose their designation after December 31, 2028, but the proposed regulations allow the basis step-up election until December 31, 2047. This means you can still be exempt from capital gains tax on your investment if you sell your interest in the QOF before December 31, 2047.
• In the original bill, investors have 180 days from the date they sell a capital asset to roll the gain into a QOF. The new regulations have more flexibility allowing the QOF to hold these funds for up to 30 months, as long as an investment plan for these funds exists.
• Investors can sell these funds in a QOF and continue to defer their gain as long as they sell their entire interest and reinvest it in another QOF.
• Partnerships can make an election to defer their capital gains at the partnership level. The partnership then has 180 days from the last day of its taxable year to invest the gains in a QOF. Individual partners can elect to defer their share of capital gains from a partnership. They have 180 days from the actual date of sale to invest in a QOF.
There are unknowns regarding Opportunity Funds. It is important to consult a financial advisor, CPA and attorney before attempting to utilize an Opportunity Fund or sell your capital asset to be invested in an Opportunity Fund. The Opportunity Fund can be a very useful investment vehicle for active and passive real estate investors.