Qualified Opportunity Zones – A Tax Planning Option
Finding ways to reduce taxes is an important exercise that both individual and business taxpayers should undertake on a regular basis. Whether it’s making an additional contribution to a retirement plan at year-end or making expenditures that qualify for bonus depreciation, it’s important to think ahead. The rules for tax planning changed significantly when the Tax Cuts and Jobs Act of 2017 (tax reform) was passed in late December of last year. Significant changes were made to the tax code which was designed to reduce taxes on businesses and certainly individual taxpayers. Key provisions such as a doubling of the standard deduction for individuals and expanded bonus depreciation opportunities were welcome. However, other changes such as the elimination of common individual credits/deductions and modifications to 1031 like/kind exchanges impacted the tax planning process. Many of the established tax planning opportunities were eliminated or significantly curbed. Taxpayers may be surprised to learn about the tax planning opportunity created by Qualified Opportunity Zones. To help clients, prospects and others understand this program and related benefits, Hanson & Co has provided a summary of key information below.
What is the Opportunity Zone Incentive Program?
Opportunity zones are a new community development program created by the Tax Cuts and Jobs Act of 2017 that were designed to incentivize investment in economically challenged urban and rural communities across the country. The program works by allowing any taxpayer (within a designated time frame) the chance to defer paying tax on the capital gains from the sale of property and other assets (such as stocks) if the gains are invested in an Opportunity Zone. It’s important to note that investment is not directly permitted, and taxpayers must make the investment with Qualified Opportunity Funds, which are primarily focused on investing in designated zones.
What are the Tax Benefits?
The program creates key tax benefits for those who participate and rewards those who keep their investment for the longest period possible. These include:
- Deferral of Gain – Similar to 1031 exchanges, taxpayers are provided a vehicle in which they can defer the gain of the sale of property and other qualifying assets by investing in opportunity funds. Regulations require participating taxpayers to recognize the gain on the date the opportunity zone investment is terminated or December 31, 2026, whichever date is earlier.
- Basis Step-Up – Participants can receive a step-up in basis for capital gains that are invested. The basis is increased by 10% if the investment is held for five years and an additional 5% if the investment is held for seven years. This creates the opportunity to exclude 15% of the original gain from taxes if the investment is held for the appropriate length of time.
- Permanent Exclusion Opportunity – Regulations allow for a permanent exclusion from taxable income on capital gains on the sale of exchange of an investment in an opportunity fund if it was held for 10 years. Please note this applies only to gains made after the opportunity fund investment was made.
Taxpayers have until 180 days after the sale of their property to make an investment in a Qualified Opportunity Fund. The election must be made at the time of investment. As mentioned above, the maximum deferral period for a Qualified Opportunity Zone is 10 years with associated tax benefits phasing in at seven and five years.
Opportunity Zones in Colorado
|The federal government has identified a list of 126 Opportunity Zones in the state of Colorado. There are nine in Denver County, four in Jefferson County, eight in Arapahoe County and four in Boulder County. There is an interactive map and more detailed information available from the state. While this information is interesting, it’s important to note that a taxpayer doesn’t have to live in or own a business in an Opportunity Zone to participate in the program. The only requirement to participate is to make an investment in a Qualified Opportunity Fund as highlighted above.
This program creates a unique opportunity for taxpayers to defer taxes on capital gains. There is a compelling tax benefit for those who meet the criteria and choose to participate. It’s important to consult a qualified advisor to review your situation and determine the best way to move forward. If you have questions about Qualified Opportunity Zones or need assistance with another tax or audit issue, Hanson & Co can help! For additional information please call us at 303-388-1010 or click here to contact us. We look forward to speaking with you soon.