Realized Chief Investment Officer Drew Reynolds recently shared details of the QOZ program created as part of the Tax Cuts and Jobs Act of 2017 and how investors may be able to defer and eliminate some capital gains tax obligations. We share a recap below, and you can read the complete article at thestreet.com.
One of the most significant provisions of the 2017 TCJA (Tax Cuts and Jobs Act) is the Qualified Opportunity Zone (QOZ) program. This program uses tax incentives to encourage investment in low-income communities across the US. Each state and territory had the opportunity to nominate eligible areas for inclusion in the designation based on the local poverty level or median household income. Ultimately, the US Treasury Department selected more than 8,700 specific census tracts for investment through the program.
Investing capital gains in a QOZ can allow the taxpayer to defer paying federal taxes on the income until they sell the investment or until December 31, 2026. While most states conform to the QOZ rules, some states do not, and investors would pay state taxes on the relevant capital gain. To use the deferral, the investor must reinvest the gains from the sale of a qualifying asset within 180 days of recognizing the growth. Investors participate in QOZ investments through QOFs (Qualified Opportunity Funds). In addition, while the invested funds are only eligible for deferral of the capital gains tax, the appreciation earned in the QOF will be exempt from capital gains taxes if the investor holds the investment for at least ten years.
A QOF is an entity that has at least 90 percent of its assets in QOZ property and earns at least 50 percent of its income from QOZ activity. The QOF must also substantially improve the owned asset within 30 months of acquisition. Furthermore, QOFs may not operate "sin" businesses like bars, casinos, or racing operations.
Some notable differences from 1031 exchange deferrals.
Unlike the deferral that an investor can obtain by executing a 1031 exchange, investors can use long-term capital gains from the disposition of stocks, bonds, livestock, art, and other items to invest in the QOZ. Furthermore, the investor does not need to divert the entire proceeds to the QOZ investment, but only the gain.
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.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.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.