Opportunity Zone
What is Opportunity Zone and is it the right investment for you?
One of the most controversial part of Trump’s tax reform (Tax Cuts and Jobs Act) is the code section 1400Z-2 AKA “Opportunity Zone” incentive. Unlike the widespread concept, there are many "hot" Opportunity Zone real estate properties in Los Angeles, New York City, and other cities where real estate has always been a profitable investment. But what exactly is Opportunity Zone and is it right for your portfolio? Here is a brief summary of how the code works (fasten your seat belt!)
First and foremost, this is at least a 10-year tax planning. So, you should manage your funds in way that you won't need to cash out this investment for the next ten years.
Opportunity Zone incentive was created to help the economy of low-income communities. The incentive has 4 parts:
1. Deferral of your eligible capital gain which you reinvest in the Opportunity Zone
2. Exclusion of 10% of that deferred capital gain after holding the property in the Opportunity Zone for five years
3. Exclusion of another 5% of that deferred capital gain after holding the property in the Opportunity Zone for another two years (total of seven years).
4. Exclusion of the capital gain arose from the sale of the property in the Opportunity Zone after 10 years.
To keep things simple, let’s give an example:
A owns a capital asset with basis of $300,000. In 2019 A sells this asset for $1.3 million, thus recognizes $1M capital gain. Normally A would have to report this gain on his 2019 tax return and pay tax on it (for the sake of argument, let’s say 40%) which is $400,000.
Now if A reinvests his $1M gain in an Opportunity Zone rental property for $1M, A will not report the gain in his 2019 return, hence defers the tax payment of $400,000 to future. A’s basis in this property will be zero. The due date for this tax payment is the earlier of December 31, 2026 or when the asset is sold. Since A plans to hold the asset for at least 10 years (soon we will see why 10 years) therefore, A will report this $1,000,000 gain on his 2026 tax return. But wait! His capital gain won’t be $1M and his tax will be less than $400,000!
After holding the Opportunity Zone property for five years, A’s basis in the property will be increased by 10% of the value of the property ($100,000) and after 2 more years (at the end of total seven years) his basis is increased by another 5% (50,000). So, on December 31, 2026 when A must report his capital gain from the sale of his asset in 2019, his taxable gain will be $850,000. Assuming the tax rates stay the same, A’s tax on his capital gain will be $340,000. So far A has saved $60,000 in tax, and has deferred the tax payment for seven years. But wait! There is more!
A holds on to his Opportunity Zone property investment for at least another 3 years (total holding period of 10 years). By that time the value of his property, let's say, has doubled (now it is worth $2M). Once A sells this Opportunity Zone property, the new $1M gain will be tax free!!! So on overall $2M gain, A tax will be only $340,000, or 17%.
In other words, the total tax that A saves in this scenario will be $460,000. Of course, the IRC code section and regulation are not as simple as it is for Mr. A, but you get a gist of what the opportunity zone is and how it works.
To have a personalized tax planning and investment strategy in Opportunity Zone, please contact Quintessential Tax Services.
One of the most controversial part of Trump’s tax reform (Tax Cuts and Jobs Act) is the code section 1400Z-2 AKA “Opportunity Zone” incentive. Unlike the widespread concept, there are many "hot" Opportunity Zone real estate properties in Los Angeles, New York City, and other cities where real estate has always been a profitable investment. But what exactly is Opportunity Zone and is it right for your portfolio? Here is a brief summary of how the code works (fasten your seat belt!)
First and foremost, this is at least a 10-year tax planning. So, you should manage your funds in way that you won't need to cash out this investment for the next ten years.
Opportunity Zone incentive was created to help the economy of low-income communities. The incentive has 4 parts:
1. Deferral of your eligible capital gain which you reinvest in the Opportunity Zone
2. Exclusion of 10% of that deferred capital gain after holding the property in the Opportunity Zone for five years
3. Exclusion of another 5% of that deferred capital gain after holding the property in the Opportunity Zone for another two years (total of seven years).
4. Exclusion of the capital gain arose from the sale of the property in the Opportunity Zone after 10 years.
To keep things simple, let’s give an example:
A owns a capital asset with basis of $300,000. In 2019 A sells this asset for $1.3 million, thus recognizes $1M capital gain. Normally A would have to report this gain on his 2019 tax return and pay tax on it (for the sake of argument, let’s say 40%) which is $400,000.
Now if A reinvests his $1M gain in an Opportunity Zone rental property for $1M, A will not report the gain in his 2019 return, hence defers the tax payment of $400,000 to future. A’s basis in this property will be zero. The due date for this tax payment is the earlier of December 31, 2026 or when the asset is sold. Since A plans to hold the asset for at least 10 years (soon we will see why 10 years) therefore, A will report this $1,000,000 gain on his 2026 tax return. But wait! His capital gain won’t be $1M and his tax will be less than $400,000!
After holding the Opportunity Zone property for five years, A’s basis in the property will be increased by 10% of the value of the property ($100,000) and after 2 more years (at the end of total seven years) his basis is increased by another 5% (50,000). So, on December 31, 2026 when A must report his capital gain from the sale of his asset in 2019, his taxable gain will be $850,000. Assuming the tax rates stay the same, A’s tax on his capital gain will be $340,000. So far A has saved $60,000 in tax, and has deferred the tax payment for seven years. But wait! There is more!
A holds on to his Opportunity Zone property investment for at least another 3 years (total holding period of 10 years). By that time the value of his property, let's say, has doubled (now it is worth $2M). Once A sells this Opportunity Zone property, the new $1M gain will be tax free!!! So on overall $2M gain, A tax will be only $340,000, or 17%.
In other words, the total tax that A saves in this scenario will be $460,000. Of course, the IRC code section and regulation are not as simple as it is for Mr. A, but you get a gist of what the opportunity zone is and how it works.
To have a personalized tax planning and investment strategy in Opportunity Zone, please contact Quintessential Tax Services.
Contact us
Email: Info@Qtaxservices.com
Phone: (424) 888-3878
Phone: (424) 888-3878