Strategic investments are integral for anyone seeking a substantial return on investment. With that said, investing in opportunity zones gives you access to tax benefits that facilitate financial freedom. What’s more, you will contribute to revitalizing underdeveloped communities in your area. However, before committing to the investment opportunity, you must understand how opportunity zones work.
What Is An Opportunity Zone?
An opportunity zone is a low-income or underdeveloped community that offers investors tax incentives to encourage economic development and employment. The government established opportunity zones in 2017 under the Tax Cuts and Jobs Act. Usually, the state will nominate several areas by census tract before the Treasury Department certifies valid opportunity zones.
How Do Opportunity Zones Work?
Generally, there are over 8,700 opportunity zones across the 50 states and U.S. territories. Investors will invest in residential properties, offices, hospitals, industrial facilities, and sustainable agriculture projects. But first, you must create a qualified opportunity fund (QOF) to qualify as an investor.
The qualified opportunity fund is an investment platform that drives all real estate and business developments within the opportunity zones. A partnership or corporation creates an opportunity fund by filling Form 8996 at the IRS under their federal tax return.
Once your organization becomes a designated opportunity fund, you must invest at least 90% of your capital gains into the opportunity zone. You can earn capital gains from selling bonds, stocks, real estate, and private businesses. Moreover, investing your assets within the first 180 days after the sale date makes you eligible for various tax benefits.
Remember, if you are an independent investor, you can allocate your assets to a qualified opportunity fund, which then invests in a QZ on your behalf. A good example of an investment group is Galena Equity Partners, a renowned investment group and development company.
What Are the Opportunity Zone Tax Benefits?
Investing in a qualified opportunity fund allows you to gain long-term profit from opportunity zones. However, the tax benefits are the significant driving force for many investors. Below are the three integral tax benefits and how to utilize them.
- Tax deferral: Tax deferral allows you to defer taxes on some or all of your capital gain until the end of 2026. If you opt to apply for tax deferral, you must defer within the first 180 days after reinvesting into the qualified opportunity fund.
- No tax on appreciation: Capital gains exclusion may be the most beneficial tax incentive for long-term investors. If a qualified fund maintains its investments in an OZ for over ten years, you will not pay taxes on all new capital gains. The exclusions still apply if you choose to sell your investment.
- The Step-up model: This model offers tax incentives through the step-up in tax basis of up to 15% of your capital gains. If the opportunity fund maintains its investments for at least five years, the basis of investment increases to 10% of the original deferred gains. Simultaneously, QOFs that hold investments for at least seven years receive a 15% tax benefit. The only downside is you must have invested in a QOF by 2021 to qualify for the five-year benefit and 2019 for the seven-year benefit.
Overall, opportunity zones have amazing tax benefits for investors. However, QOFs can’t invest in businesses such as massage parlours, liquor stores, country clubs, and golf courses. Instead, you can work with an investment group experienced in managing qualified funds to get the best out of your investment.
