Much of the discussion concerning Qualified Opportunity Zones (QOZs) investments seems to involve real estate sales. Capital gains from those dispositions can be put toward a Qualified Opportunity Fund (QOF), which then reinvests those monies into a federally designated Opportunity Zone.
But the program isn’t just limited to capital gains from a real estate sale. Any type of capital asset can qualify, including those generated by the sale of publicly-traded stocks.
Defining "stocks"
Corporate stocks are securities “that (give) stockholders a share of ownership in a company,” according to the Securities and Exchange Commission. People invest in stocks for capital appreciation and dividends, in which a corporation distributes some of its profits, or earnings, to shareholders.
Investors can buy common stocks and preferred stocks. Those with common stocks receive dividends, and vote at shareholder meetings. Preferred stockholders typically don’t have voting rights, but they do receive dividend payments before common stockholders. They also have priority over common stockholders if a corporation heads into Chapter 7 bankruptcy and asset liquidation.
Publicly traded stocks are just one type of capital asset.
A capital gain/QOF primer
To understand the concept behind capital gains, it’s a good idea to understand capital assets. The IRS defines capital assets as items “you own and use for personal or investment purposes . . .” This can include personal-use items, such as kitchen appliances or household furnishings, as well as items held for investment. This latter category includes art, gold coins, real estate . . . and stocks. A capital gain is defined as an increase of a capital asset’s value.
For example, let’s say you buy 100 shares of a stock for $50 per share. Your total investment -- also known as the cost basis -- is $5,000. After five years, you sell that stock for $65 per share, giving you $6,500. The capital gain on that sale is $1,500, or the total obtained calculated from how much you received from the transaction, less the stock’s cost basis. The capital gain is also what the IRS taxes.
To determine how much is owed, the IRS divides asset investments into two categories: short-term and long-term. Assets held for one year or less before a sale are short-term investments. Those held for a year or longer are defined as long-term investments. The difference is important, as the IRS taxes gains at different amounts, depending on the hold periods.
You can defer paying taxes on those gains for several years by investing them into a Qualified Opportunity Fund. You can also place existing assets with accumulated capital gains into those QOFs. Much like the recognized gains from asset sales, those existing capital gains aren’t taxed until the end of 2026, or when you sell the asset, whichever is sooner.
Other benefits of placing your gains into a QOF are:
- Step-up basis of previously earned capital gains; while the deadline for the 5% basis step-up in basis has passed, you can still benefit from a 10% basis step-up on QOF investments made after Dec. 31, 2019.
- Permanent exclusion of taxes on new gains, as long as you hold onto that QOF investment for at least 10 years.
Tax credits, NMTCs, and QOZs
Finally, another question linked to QOF investments involves tax credits. Tax credits are monies you can subtract directly from taxes owed. Such credits are useful; they represent another type of tax shelter.
The confusion arises from QOZ comparisons to the New Market Tax Credit Program. The NMTC is similar to the Opportunity Zones program in that it encourages private capital to invest in low-income communities through vehicles known as Community Development Entities. In return for the investment, the taxpayer receives a 39% credit against income taxes, spread over a seven-year period.
But the QOZ and NMTC programs differ in that the former isn’t a tax credit program, as much as it’s a tax deferral program. When investing in a QOF, you will eventually pay taxes on capital gains from your corporate stocks. As of right now, the QOZ program will expire on Dec. 31, 2026. This means you’ll owe taxes on those capital gains when you file your return in 2027.
The takeaway
The capital gains component of the Opportunity Zone program has focused more on the sale or accumulated gains involved with real estate. But the program doesn’t discriminate as to the asset generating those capital gains, as long as the amount is invested in a QOF according to IRS-mandated deadlines and rules. As such, if you have those capital gains, investment in a Qualified Opportunity Fund could represent an important tax shelter to help maintain your investment and portfolio goals.
For additional understanding and information about Opportunity Zone investments, contact Realized Holdings by logging on to www.realized1031.com, or calling 877.797.1031.
There are material risks associated with investing in QOZ properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.
Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation.
This is not a solicitation or an offer to sell any securities. There is no guarantee that the investment objectives of any particular program will be achieved.
