New Opportunity Zone investments in 2022 will enjoy slightly less benefits than investments made in prior years. However, investors can still avoid future federal capital gains taxes by investing in Opportunity Zones (which has always been the principal benefit of Opportunity Zone investing).
As background, in order to qualify for Opportunity Zone tax benefits you must first realize a capital gain by selling any capital asset. Within 180 days of realizing a capital gain, you must invest in a Qualified Opportunity Fund (QOF). However, if you own an LLC, partnership or S Corporation which realized a capital gain last year, your investment period can extend to as far as this upcoming September. And, only the portion of any sales proceeds that represents gain must be invested in a QOF (not the entire proceeds from the sale of a capital asset).
By investing in a QOF you will enjoy the following tax benefits:
- Income taxes on capital gains realized and reinvested in the QOF are deferred through December 2026.
- If you maintain your QOF investment for 10 years, you can sell your investment without paying any federal income tax.
A QOF can be any LLC that (i) elects to be treated as a QOF for income tax purposes, (ii) is formed for the purpose of investing in Opportunity Zones and (iii) invests in Opportunity Zone property. The QOF can either purchase Tangible Opportunity Zone Property (e.g., real estate project) directly or it can invest in a Qualified Opportunity Zone Business (QOZB), which purchases Tangible Opportunity Zone Property. By investing in a QOZB rather than purchasing Tangible Opportunity Zone Property directly, the QOF can (i) reduce the total amount of investment in Tangible Opportunity Zone Property and (ii) extend the timeline for acquiring and/or constructing Tangible Opportunity Zone Property.
As an example, if you sell a capital asset for $1,000,000 and realize a gain of $250,000, you can invest $250,000 in a QOF within the reinvestment period. In which case, (i) the federal tax on your $250,000 gain will be deferred through 2026 and (ii) if you hold your investment for 10 years, no federal tax will be due on a future sale of your new investment. There is no limit on the amount of gain which is excludible or deferrable pursuant to this tax incentive. However, it is important to note that while California investors and investments based in California are eligible for the federal tax incentive; there is no California state income tax benefit for such investments.
There are many complexities associated with Opportunity Zone investing. However, relative to other tax-advantaged investments, Opportunity Zone rules and regulations are very investor friendly.
For more information, please contact a member of Glaser Weil’s Tax Department.