For a limited time, investors can help reinvigorate distressed communities while deferring capital gains on profits earned elsewhere. The 2017 Tax Cuts and Jobs Act created the Qualified Opportunity Zone program in order to offer tax incentives for investment in economically blighted communities. When you invest in an Opportunity Zone, you can defer and possible reduce taxes on recognized capital gains. If you will be subject to a large tax bill as a result of capital gains in the near future, an Opportunity Zone investment may be worth exploring.
An Investment that Defers Capital Gains
Opportunity Funds are investment vehicles that allow investors to defer capital gains for up to 10 years and possibly receive greater tax advantages. To do so, investors need to reinvest capital gains (from any investment, such as stocks, real estate or business interests) into certain census tracts, which are designated as Opportunity Zones.
Each state nominated communities they wanted included in the program. To qualify, census tracts had to meet a Low Income Community requirement or have a poverty rate of 20 percent or greater. The goal is that investments in these impoverished communities will promote sustainable economic growth and help narrow the gap between them and their more affluent neighbors.
There are approximately 8,700 Opportunity Zones nationwide, including all 50 states, Washington, D.C., and U.S. territories.
To qualify for the program, an Opportunity Zone Fund must have 90 percent of its assets in a qualified Opportunity Zone property and must make substantial improvements to that property. Those are defined as improvements equal to the fund’s initial investment in the property, over a 30-month period.
Massachusetts Opportunity Zones
The following is a list of counties and tract numbers designated as Opportunity Zones.
| Barnstable 25001010100 25001011600 25001012002 25001014100 25001014500 25001015300 25003900100 25003900200 25003921400 25003922100 25003922300 25003935300 |
Bristol 25005613800 25005630101 25005630102 25005641101 25005641200 25005642000 25005644200 25005651200 25005651300 25005651800 25005651900 25005655300 |
Hampden 25013800600 25013800900 25013801101 25013801200 25013801700 25013801800 25013801902 25013810300 25013810403 25013810800 25013811400 25013811700 25013812300 25013812702 25013813207 |
Franklin 25011040100 25011040400 25011040501 25011040502 25011040701 25011041300 25011041400 |
| Suffolk 25025040200 25025040300 25025040801 25025060700 25025061000 25025061101 25025080500 25025080601 25025081200 25025090901 25025160200 25025160400 25025170501 25025170702 25025180500 25025980101 25025980300 25025981100 |
Essex 25009204200 25009204701 25009206100 25009206800 25009207000 25009207200 25009208102 25009210700 25009210800 25009217400 25009221400 25009221500 25009250100 25009250300 25009250800 25009251600 25009252300 25009252400 25009260200 25009260800 |
Middlesex 25017310100 25017311600 25017311700 25017311800 25017311900 25017321200 25017321300 25017339700 25017341200 25017341300 25017342400 25017350103 25017351500 25017354900 25017383101 25017383102 |
Worcester 25027703100 25027703200 25027707200 25027707300 25027709400 25027709600 25027710600 25027710700 25027716200 25027716300 25027726200 25027730500 25027731300 25027731400 25027731700 25027732500 25027732801 25027754200 25027757100 25027757300 |
| Plymouth 25023510503 25023510700 25023510900 25023511000 25023545400 25023561200 |
Norfolk 25021417701 25021417901 25021420202 25021420301 25021422502 |
Hampshire 25015820102 25015820300 25015821100 25015821602 25015821903 25015822402 |
Three Ways to Save
Investors in an Opportunity Fund can potentially save taxes in three ways:
- Tax deferral. Taxable gains in an Opportunity Zone Fund are not recognized until 2026 or until the interest in the fund is sold or exchanged, whichever comes first.
- Capital gains tax deduction. When you defer gains through an Opportunity Zone Fund, you receive a 10 percent step-up in
tax basis after five years and an additional 5 percent step-up after seven years. Due to the 2026 deadline, you’d have to invest in 2019 to get full advantage of the 15 percent step-up. - No tax on appreciation. If you remain in the fund for at least 10 years, the capital gains tax is eliminated on the future sale of the investment. Essentially, the cost basis of the property becomes equal to the fair market value on the date of the sale. You do still have to pay the deferred taxes on your original investment.
Example Scenario
Imagine you realize $250,000 in capital gains in 2019. If you roll those gains into an Opportunity Zone Fund within 180 days, none of those gains are taxable this year. After five years, you’ll earn $25,000 in stepped-up tax basis in the fund (10 percent of $250,000). After two more years, you’ll earn another $12,500 of stepped-up basis. At a 23.8 percent tax rate, that’s nearly $9,000 in tax savings.
Now, let’s say you waited until 2029 to sell the investment at an appreciated value of $450,000 (roughly 6 percent annual rate of return.) You’d have $200,000 in gain that would not be taxable. However, you’d still have phantom income on your original $250,000 invest- ment (minus the 15 percent reduction), in 2026 when, per program deadlines, the deferred gain had to be recognized.
In total, that yields approximately $56,600 in tax savings over 10 years ($9,000 in capital gains deduction and $47,600 in capital gains tax eliminated). Your 10- year net, in this scenario, is just shy of $400,000.
Instead, imagine you’d paid the capital gains tax on that $250,000 in 2019 ($59,500 at 23.8 percent) and then reinvested the remainder ($190,500) at a 6 percent annual return. If you sold the investment at the end of 10 years (at a value of $341,000) and paid capital gains taxes again ($35,700), you would net just over $300,000.
Summary
If you have questions about this new investment and whether it would be a prudent part of your wealth management plan, reach out to your estate planning attorney. Be sure you understand the investment risks involved.
Just like other investments, the fund may increase or decrease in value. Due diligence is essential when choosing funds, especially because this is a new incentive program.