There are many types of investors in this world. Some are very hands-on and know exactly what is happening with each investment. Others are less hands-on but still like to know a bit about how their investments are doing. Then, there are the passive investors. There is a place for each type of investor because every investment — from stocks to commercial real estate properties — needs investment funds to thrive. Every investor, no matter what type, has goals for their investment portfolio. For some, they just want to see growth. Others want to take advantage of as many opportunities and tax benefits as possible.
For investors who want to see tax benefits — and let’s face it, even passive investors interested in slow but steady growth love tax benefits — the U.S. government has created unique opportunities to take advantage of tax deferrals on capital gains. When an investor receives a capital gain from the sale of any asset (stocks, bonds, real estate, etc.), they can reinvest those funds into certain properties in specific areas identified by states and the Treasury Department. The qualified opportunity zone investment program is a great way for active and passive investors to utilize tax deferral benefits for capital gains by investing in a new QOZ business property. Here is a closer look at the business in a QOZ program, the benefits investors often love with these investments, and what you need to know if you want to invest in a QOZ in 2021.
What is a Qualified Opportunity Zone?
A qualified opportunity zone, also known as a QOZ, is any community nominated by the state and certified by the Treasury Department to qualify for the program. The program creates tax incentives for investors who invest in certain areas (typically low-income areas). There are QOZs in every state, Washington, D.C., and many U.S. territories.
QOF’s Role in QOZ Investments
Within the realm of QOZs is something called a qualified opportunity fund (QOF). This is one way investors can take advantage of the QOZ benefits and get involved in a QOZ property. An investor has a 180 day period from a sale to invest the capital gains dollars into a QOF. This fund will then invest in a QOZ property. A QOF is any investment vehicle that is organized as a corporation or a partnership in order to invest in a QOZ property and holds at least 90 percent of the assets in that QOZ property. Because the QOZ program is designed to improve certain areas, a QOF should continue to invest in the property’s improvement over time.
These funds mean that an investor can sell off any appreciated assets (like stocks) in addition to commercial properties, and reinvest those funds into QOFs, meaning that there is no like-kind investment requirement. An investor who receives capital gains from a flow-through entity like a partnership, S-corp, or estate or trust has 180 days from the end of the calendar year to invest in a QOF. This 180-day timeline is true no matter how early in the calendar year capital gain was realized. So if a partnership entity realizes a capital gain in March, each investor has a 180-day triggering date that will be December 31 of that year.
A QOF is a tax planning tool and investment option for investors, so just like any other investment, a QOF has its risks. Some of the potential risks include market loss, liquidity risk, or business risk. These funds offer a good way for many investors to diversify their investment portfolios with QOZ properties.
Qualified Opportunity Zone Properties
A qualified opportunity zone property needs to meet a few key requirements.
- Acquired after December 31, 2017
- Used in a trade or business conducted in a QOZ or ownership interest in an entity that operates within such a property
- There must be substantial improvement to a property that is already being used in the zone within a specified timeline (30 months)
Benefits of Investing in a QOZ Property
There are many benefits for investors interested in acquiring a QOZ property. Benefits that appeal to many investors include the ability to diversify their portfolios and the many tax benefits that come along with a QOZ investment property. The three primary tax benefits include:
- Temporary capital gains tax deferral: Investors get a temporary deferral of inclusion of capital gains in taxable income. The deferral is only applicable for capital gains reinvested in a QOZ property or QOZ fund. The deferred gain must be recognized before the investment expiration date or before December 31, 2026.
- Step-up in basis for capital gains: Investors will get a step-up in the basis for capital gains reinvested into a QOZ or property. The basis is increased by 10 percent if the investment in the QOZ is held for 5 years. If this investment is held for at least 7 years, then the step-up increases by an additional 7 percent, meaning investors can see a step-up basis increase that will exclude up to 15 percent of the original capital gain from taxation.
- Permanent exclusion: If the initial investment is held for at least 10 years, then the investor can get a permanent exclusion of taxable income on capital gains from the sale of an investment into a QOZ. The exclusion will only apply to capital gains accrued after the investment made into the QOZ.
Can You Still Invest in Opportunity Zones in 2021?
Yes, you can definitely still invest in a QOZ in 2021. In fact, 2021 is a great time to invest in QOZ funds for one key reason. Investments into opportunity zones can be made until December 2026. However, because investments must be held for 5 years in order to qualify for a 10 percent basis step up for gain exclusions, an investment needs to be made by the end of 2021 in order to see the full benefits of this investment for tax purposes.
The opportunity zone program was designed to encourage long-term real estate investments in specific areas with these stipulations and incentives:
- QOZ property held for less than 5 years: Deferred payment of existing capital gains until the date that the Opportunity Fund investment is sold or exchanged
- QOZ property held for 5 to 7 years: 10 percent of the tax on existing capital gain is canceled
- QOZ property held for 7 to 10 years: Deferred payment of existing capital gains until December 31, 2026, or whenever the investment is sold or exchanged and 15 percent of the tax on existing capital gain is canceled
- QOZ property held for longer than 10 years: Investors pay no capital gains tax on the QOZ investment
Are Opportunity Zones a Good Investment?
Opportunity zones can be a great investment for investors who want or need certain federal income tax benefits, and for those who may be interested in a passive investment opportunity with the QOF. However, investors interested in investing in QOZ properties or businesses or a QOF need to keep a few things in mind in order to fully realize the tax cuts and jobs associated with opportunity zone investments.
Key Things to Keep in Mind with Opportunity Zone Investments
When an investor wants to take advantage of all of the benefits that a QOZ investment has to offer, they need to make sure they follow the timelines and deadlines.
By the end of this calendar year (December 31, 2021), the five-year deadline will have passed to receive the 10 percent basis step up for capital gains. This deadline can be important for many investors who want to see that tax benefit.
To qualify for a capital gains tax advantage, then investors need to reinvest capital gains within 180 days of the sale of a property. However, investors do not have to use the full gain amount — but only the portion of the gain that was reinvested does qualify for the tax advantages.
Capital gains from stock, real estate, or other investment sales qualify for opportunity fund investments. This does not have to be a like-kind investment in order to be utilized for tax deferral purposes.
Investors can utilize a QOF, a fund that pools investments for multiple assets. This can be a great opportunity for investors to diversify a portfolio. But the same timelines and deadlines apply to qualified opportunity funds as to individual QOZ properties.
Get Expert Help with QOZ Investments in 2021
In order to fully take advantage of the tax benefits that QOZ investments can provide, you need to work with a qualified professional who can help you identify the right properties and stick to the timelines necessary to ensure the capital gains tax deferral benefits. The experts at Sands Investment Group have experience helping investors find qualified opportunity zones and funds to invest capital gains from sales of other properties or assets. The brokers at SIG can answer your questions and help you identify the right opportunities for your investment portfolio. Contact us today to learn about investing in a QOZ or QOF by calling 844.4.SIG.NNN or sending an email to info@SIGnnn.com.