Opportunity Zones, a program created by the bipartisan Tax Cuts & Jobs Act of 2017, mobilizes huge amounts of unrealized capital gains to invest in the redevelopment of more than 8,700 low income census tracts designated as Qualified Opportunity Zones (QOZs). A first of its kind tax incentive program, opportunity zones incentivize private capital to work alongside public dollars to redevelop distressed areas by creating jobs, new businesses, affordable housing and economic stability. Another benefit? Unprecedented tax savings for investors.
Opportunity Zones work by incentivizing investors to take capital gains, pre-tax, and invest them in qualified opportunity funds (QOFs). The tax incentives vary by when the investment was made, and how long it is held. One key benefit expired on December 31, 2021, but there are still other tax incentives in play. So, does it still make sense to invest in OZs in 2022 and beyond? Absolutely
The early years of OZs, 2018-2021, offered early adopter incentives to investors. For example, taxpayers who invested in QOFs in 2018 and 2019 and left the money invested for at least 7 years received a 15% step-up in basis on the original investment. Investments made in 2020 and 2021 received a 10% step-up in basis on the original investment, when the money stayed in the investment for a minimum of 5 years. This means that 10% of the invested, pre-tax capital gains are now tax free.
Let’s say that an investor has $1,000 in capital gains they want to invest in a QOZ. If they had invested before the end of 2021, and held the investment for at least 5 years, they would have received a 10% step-up in basis, meaning $100 of the $1,000 investment would have become tax-free. Unfortunately, the step-up incentive expired on Dec 31st, 2021. Now that we are in 2022, there is no step-up in basis offered for new investments in QOZs. However, investors can still take advantage of significant tax benefits with OZs.
The step-ups in basis for early investors were great tax incentives, but they were never the crux of the benefit from investing in QOZs. Two major benefits remain for taxpayers investing in 2022 and beyond:
Returning to our example of an investor taking $1,000 of capital gains and investing in a QOZ, the investor would need to pay the capital gains tax on the original $1,000 invested at the end of 2026. Some QOFs will offer plans to restructure or refinance in time to pay investors out with enough to cover these taxes that will become due, but it will be up to the investor to determine if that is the case or to make other plans to make those payments at that time. However, the major benefit is that rather than paying your capital gains tax in 2022 or at the time of investment, the money that would have gone to federal tax is invested in an opportunity fund and potentially earning gains that will be tax free. So, it will be even more important for investors to do their homework and make sure they are confident that the QOFs they are investing in have potential to appreciate.
With the benefit of Opportunity Zones relying heavily on the quality of the investment, single-asset QOFs are increasingly attractive to potential investors. Why? They offer investors a greater understanding of the specific product they are investing in, with more ability to calculate the potential ROI when considering the tax breaks offered by OZs. OZ FundHub is here to be a resource for investors in matching with QOFs that meet your goals. Visit our learning center and keep reading our blog to learn more.
*Important Notice: OZ FundHub is not a licensed tax, accounting, or financial firm. All Information contained is for educational purposes only.*