Opportunity Zones, Part II: The Tax Benefits of Opportunity Zone Investment

The longer you hold qualified opportunity zone property, the greater the tax benefit.

Opportunity Zones is a new community development program enacted by Congress to encourage investment in distressed communities in exchange for substantial tax breaks. The program promises to attract new sources of funding for economically-disadvantaged areas of the country that haven’t previously been the focus of real estate investors and venture capitalists.

Capital gains deferral, discount, and dismissal

Investment in an opportunity zone can provide investors with some extraordinary tax benefits. If you have a capital gain from any source, rather than pay taxes on it in 2018 you can reinvest in an opportunity zone and refrain from paying capital gains taxes until you sell or exchange it, or until December 31, 2026 (whichever is sooner).

Per 26 U.S. § 1400Z-2(b)(2)(B)(iii)-(iv), if you retain your opportunity zone investment for five years, you get a 10% step-up in basis. If you keep it for seven years, you get an additional 5% — and can exclude a total of 15% of your original capital gain from taxes.

If you hold out even longer, you can eliminate your tax liability entirely. No capital gains taxes are owed by taxpayers who stay invested in an opportunity zone for 10 years or more, regardless of how much the investment has increased in value. All you need to do is hold on to qualified opportunity zone property and make an election to defer your original capital gains. You will be able to do this even after the designation of all qualified opportunity zones expires on December 31, 2028.

Length of Investment Tax benefits
< 5 years Deferred capital gains until sold or exchanged
5-7 years Deferred capital gains until sold or exchanged plus 10% step-up in basis
7-10 years Deferred capital gains until sold or exchanged, or until December 31, 2026 (whichever is sooner), plus 15% step-up in basis
>10 years No tax on capital gains from opportunity zone property

Even if an opportunity zone loses its designation, you can retain the tax benefits of opportunity zone investment through the year 2047.

Remember that in addition to the tax savings, you can spend the money that otherwise would have gone to the IRS to make additional investments!

Proposed Regulations offer guidance

The tax benefits of the Opportunity Zone Program can only be utilized if you follow specific rules regarding the structure and type of your investment. The U.S. Treasury Department recently provided guidance to investors seeking to take advantage of this new tax code section. These Proposed Regulations provide a clear explanation of how to properly utilize Opportunity Zones for your benefit and for the benefit of disadvantaged communities throughout the country.

In our next post, we will provide a basic outline of the opportunity zone investment rules as explained in the proposed regulations.