For decades, real estate investors have had the option of deferring capital gains taxes through a 1031 exchange (also known as a tax-deferred exchange). This is still a sterling investment, but now, there’s another tool that is just as conducive to deferring taxes and even eliminating taxable profits altogether: Opportunity Zones.
Opportunity Zones were established as tax incentives to invest by the 2017 Tax Cuts and Jobs Act. They allow you to invest in disadvantaged areas in the US to spur economic development and job creation in low-income communities. In simplest terms, an Opportunity Zone is a geographic area (urban or rural) where economic growth has been lagging behind, and where new investments may qualify for preferential tax treatment under certain conditions.
These designated zones are located across all 50 states, five US territories, and the District of Columbia. There are low-income communities throughout the country that are in need of economic revitalization. Correlating to this, there are many properties in these areas that show immense potential and are ripe for economic development. Opportunity Zones are approved by the Internal Revenue Service and certified by the Secretary of the US Treasury Department.
You can enjoy many tax benefits by investing through a Qualified Opportunity Fund (QOF), which is an investment vehicle – similar to a partnership or an LLC – created specifically to invest in properties located within opportunity zones. In order to be a QOF, a property must meet certain criteria. For example, it must be either newly constructed or have undergone major renovations. It's prohibited to buy existing property in Qualified Opportunity Zones without making significant improvements.
What exactly is a "significant improvement"? It's any renovation/remodeling that is equal to greater than the total value of the real estate asset and must be finished within 30 months.
The biggest advantage of opportunity zones is capital gain tax deferrals from your previous investments. To be more specific, investors who transfer their capital gains from prior investments into qualified opportunity funds within 180 days of the sale date can defer all federal capital gains taxes on that gain until the 31st of December, 2026.
For both short- and long-term realized capital gains, opportunity zones can be an excellent option. These gains could be from the sale of an appreciated capital asset (art, currency, stocks, bonds, and so on), the sale of a closely-held business, or the sale of real estate.
In relation to this, if QOF investors hold their investments for at least 5 years, they can reduce their deferred capital gains even further. This is possible because their cost basis will go up by 10% by then. People who can hold on to their QOF investments for ten years or more are able to enjoy 100% gains, totally free of capital gains tax liability. If your goal is to create serious wealth in the future, this gives you a clear competitive advantage.
Note: Since deferred taxation on 31st December 2026 will happen prior to the 5-year holding period being met, any investment made after 31st December 2021 will not qualify for the 10% basis step-up.
1031 exchanges and qualified opportunity zone investments offer numerous advantages to real estate investors, including substantial tax advantages and the ability to leverage their money with minimal financial obligations. But to get the most out of these investment vehicles, you must comply with specific rules and timeframes.
Our dedicated team at Pivot Professional Partners can help you determine an investment strategy based on your short- and long-term goals as well as your equity and income objectives. We can also advise you on reinvesting gains from a property sale for tax deferral, and how to do it efficiently so as to meet your personal goals.
Call us at (631) 275-1444 or contact us online for any legal or tax advice regarding the qualified opportunity zone program.