The Tax Cuts and Jobs Act of 2017 brought sweeping change across our federal tax code. Its goal of tax simplification resulted in the elimination and/or limitation of many itemized deductions that have benefited residents of high tax states. With that, many financial planners, attorneys, and accountants are searching for new ways to help their clients save on taxes. One strategy that we have been discussing with clients is the ability to invest in Qualified Opportunity Zones.
What Are Qualified Opportunity Zones?
Opportunity Zones are areas specified by state governments that are typically low-income rural areas or urban communities. The program goal is to drive long-term capital investment to these distressed areas by offering tax incentives to investors who allocate some of their wealth there. States are currently at various stages in the approval process. Some, such as New Jersey, have had their recommended opportunity zones approved, while others are still waiting on permission to move forward from the U.S. Department of Treasury.
To view an interactive map illustrating the opportunity zone tracts across New Jersey, click here (external link provided by the NJ Department of Community Affairs). A list of the nominated census tracts in New York can be found here (external link) per the Empire State Development website.
What Are The Benefits of Qualified Opportunity Zones?
If invested long enough, the tax benefits are two-pronged: tax-deferral on current gains plus complete tax avoidance on the investment in an Opportunity Zone. The table below will help illustrate the approach.
|Sale of an Investment||This can include real estate, portfolio assets, etc. An investor sells portfolio assets with a capital gain of $500,000.|
|Invest in Qualified Opportunity Zone||Invest that $500,000 gain into a QOZ within 180 days to defer paying taxes on that gain. The investor’s basis in this opportunity zone is $0.|
|5-Year Holding Period||There is a 10% basis adjustment after 5 years. In this case, basis in the QOZ becomes $50,000 (10% * $500,000 deferred gain).|
|7-Year Holding Period||There is an additional 5% basis adjustment after 7 years. In this example, it’s $25,000. Your total basis is now $75,000.|
|December 31. 2026 – Recognition||This date is written into the law as the “recognition date.” At this time, the investor will be required to pay taxes on the deferred gain. In this case, you would recognize a capital gain of $425,000 ($500,000 original gain – $75,000 adjusted basis).|
|10+ Year Holding Period||Sell your investment in the opportunity zone after 10 years. The basis becomes whatever the fair market value of the investment is on that date. So, if the original $500,000 investment is then worth $1,000,000, your basis becomes $1,000,000. In other words, the entire $500,000 gain is excluded.|
Assuming the maximum capital gains rate plus a surtax, the result is a $119,000 tax savings on your Opportunity Zone investment.
What Are The Risks?
As illustrated, the tax benefits can be massive – especially on the concurrent investment into an Opportunity Zone. It is important to point out that there are a number of risks associated with this strategy.
- Liquidity: In order to reap the full tax benefits, investors’ money must be left in this investment for 10 or more years. If you do not have enough liquidity to fund your financial goals, then this is not an appropriate investment.
- Investment Risk: Keep in mind that at the core, these are investments in distressed rural and urban areas. The direction in the value of these assets over time is a calculated guess, but still a guess and it may take a strong stomach to ride this out. Our Investment Team is also discussing how to consider investments in Qualified Opportunity Zones in the context of clients’ overall portfolios.
- Legislation: This is a brand-new strategy that is still being finalized at the federal and state level. There are sure to be bumps in the road and questions will arise as the Opportunity Zone strategy starts to gain traction among investors.
How Can I Invest?
This strategy is unprecedented and firms are working to introduce investment vehicles throughout the year. There are a couple of ways to participate. One, investment companies are developing funds that allow investors to pool their money. Those companies will then direct the investment of investor dollars – just as mutual fund managers do. The other way is to invest directly in a property located within one of the specified tracts.
Who Should Consider?
Anyone with significant unrealized gains in their taxable account(s) should at least have a conversation about investing in Opportunity Zones. The goal of this strategy – attempting to boost struggling economies within the country – may be more appealing to investors who find value in charitable giving or in implementing our Environmental, Social & Governance (ESG) investment philosophy as well. Given the risks outlined above, however, Opportunity Zones are not appropriate for everyone. Those who rely heavily on their portfolios to support their lifestyles may not be able to afford to tie their money up in such a long-term investment.
Please contact your Wealth Advisor and/or accountant if you would like to have a deeper discussion about Qualified Opportunity Zones and whether or not this strategy fits into your overall financial picture.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.
This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.