The idea behind the Opportunity Zone program is that individuals and entities are encouraged to direct their capital gains from the sale of capital assets toward a Qualified Opportunity Fund (QOF). In return, the individuals and entities can receive certain tax benefits. One benefit involves the possible deferral of capital gains taxes.
But can investment in a Qualified Opportunity Zone (QOZ) offset short-term capital gains? The answer is no.
What IS a Short-Term Capital Gain?
If an investor sells a capital asset for more than what they paid for it, this generates a capital gain. The IRS divides capital gains into two parts:
A short-term capital gain occurs when the asset is held for one year or less. This capital gain is taxed as ordinary income and is based on the investor’s tax bracket. The top income tax bracket is 37%.
A long-term capital gain occurs when the asset is held for longer than one year. This capital gain is taxed at the capital gains rate. This is also based on the investor’s tax bracket. But most investors will likely be taxed at 15%.
Furthermore, investors can use that capital gain to invest in a QOF, with the potential to defer taxes on that gain.
Offsetting that Short-Term Capital Gain
It’s possible to funnel either short-term or long-term capital gains into a QOF. This is, after all, part of the reason why the program was launched. But offsetting a short-term capital gain is a different story. Specifically, the only tool that can be used to offset a short-term capital gain is a short-term capital loss. A short-term capital loss occurs:
- With an asset held for less than one year
- When the investor sells that asset for less than what was paid for it
Once the investor uses a short-term capital loss against a short-term capital gain, only then can they potentially use any long-term capital loss against that short-term gain.
But again, there are a couple of caveats:
- The long-term capital loss can offset a short-term capital gain ONLY AFTER that capital loss has been used to offset any long-term capital gain
- The limit of that long-term capital loss in any given year is $3,000
In other words, short-term losses against short-term gains. And long-term losses against long-term gains. Once these have been matched, it’s possible to match short-term losses against long-term gains and vice versa. This is a strategy known as tax loss harvesting. But it has nothing to do with QOF investments.
The Purpose of Opportunity Zone Investment
Again, the Opportunity Zone program was set up to help funnel the trillions of dollars of capital gains into urban revitalization efforts. As such, while it’s possible to invest short-term or long-term capital gains into a Qualified Opportunity Fund and benefit from potential tax deferrals on that amount, the program has nothing to do with offsetting capital gains.
Additionally, investing in QOFs requires research and due diligence. As such, it’s important to check with a qualified tax professional or financial planner before making such a move.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Investors in QOFs will need to hold their investments for certain time periods to receive the full QOZ Program tax benefits. A failure to do so may result in the potential tax benefits to the investor being reduced or eliminated.
If a fund fails to meet any of the qualification requirements to be considered a QOF, the anticipated QOZ Program tax benefits may be reduced or eliminated. Furthermore, a fund may fail to qualify as a QOF for non-tax reasons beyond its control, such as financing issues, zoning issues, disputes with co-investors, etc.
Distributions to investors in a QOF may result in a taxable gain to such investors.
The tax treatment of distributions to holders of interests in a QOF are uncertain, including whether distributions impact the aforementioned QOZ Program tax benefits.
A QOF must make investments in Qualified Opportunity Zones, which carries the inherent risk associated with investing in economically depressed areas.
