For a limited time, investors can help reinvigorate distressed communities while deferring capital gains on profits earned elsewhere. The 2017 Tax Cuts and Jobs Act created the Qualified Opportunity Zone program in order to offer tax incentives for investment in economically blighted communities. When you invest in an Opportunity Zone, you can defer and possible reduce taxes on recognized capital gains. If you will be subject to a large tax bill as a result of capital gains in the near future, an Opportunity Zone investment may be worth exploring.

An Investment that Defers Capital Gains

Opportunity Funds are investment vehicles that allow investors to defer capital gains for up to 10 years and possibly receive greater tax advantages. To do so, investors need to reinvest capital gains (from any investment, such as stocks, real estate or business interests) into certain census tracts, which are designated as Opportunity Zones.

Each state nominated communities they wanted included in the program. To qualify, census tracts had to meet a Low Income Community requirement or have a poverty rate of 20 percent or greater. The goal is that investments in these impoverished communities will promote sustainable economic growth and help narrow the gap between them and their more affluent neighbors.
There are approximately 8,700 Opportunity Zones nationwide, including all 50 states, Washington, D.C., and U.S. territories.

To qualify for the program, an Opportunity Zone Fund must have 90 percent of its assets in a qualified Opportunity Zone property and must make substantial improvements to that property. Those are defined as improvements equal to the fund’s initial investment in the property, over a 30-month period.

Massachusetts Opportunity Zones

The following is a list of counties and tract numbers designated as Opportunity Zones.

Barnstable
25001010100
25001011600
25001012002
25001014100
25001014500
25001015300
25003900100
25003900200
25003921400
25003922100
25003922300
25003935300
Bristol
25005613800
25005630101
25005630102
25005641101
25005641200
25005642000
25005644200
25005651200
25005651300
25005651800
25005651900
25005655300
Hampden
25013800600
25013800900
25013801101
25013801200
25013801700
25013801800
25013801902
25013810300
25013810403
25013810800
25013811400
25013811700
25013812300
25013812702
25013813207
Franklin
25011040100
25011040400
25011040501
25011040502
25011040701
25011041300
25011041400
Suffolk
25025040200
25025040300
25025040801
25025060700
25025061000
25025061101
25025080500
25025080601
25025081200
25025090901
25025160200
25025160400
25025170501
25025170702
25025180500
25025980101
25025980300
25025981100
Essex
25009204200
25009204701
25009206100
25009206800
25009207000
25009207200
25009208102
25009210700
25009210800
25009217400
25009221400
25009221500
25009250100
25009250300
25009250800
25009251600
25009252300
25009252400
25009260200
25009260800
Middlesex
25017310100
25017311600
25017311700
25017311800
25017311900
25017321200
25017321300
25017339700
25017341200
25017341300
25017342400
25017350103
25017351500
25017354900
25017383101
25017383102
Worcester
25027703100
25027703200
25027707200
25027707300
25027709400
25027709600
25027710600
25027710700
25027716200
25027716300
25027726200
25027730500
25027731300
25027731400
25027731700
25027732500
25027732801
25027754200
25027757100
25027757300

 

Plymouth
25023510503
25023510700
25023510900
25023511000
25023545400
25023561200
Norfolk
25021417701
25021417901
25021420202
25021420301
25021422502
Hampshire
25015820102
25015820300
25015821100
25015821602
25015821903
25015822402

Three Ways to Save

Investors in an Opportunity Fund can potentially save taxes in three ways:

  1. Tax deferral. Taxable gains in an Opportunity Zone Fund are not recognized until 2026 or until the interest in the fund is sold or exchanged, whichever comes first.
  2. Capital gains tax deduction. When you defer gains through an Opportunity Zone Fund, you receive a 10 percent step-up in
    tax basis after five years and an additional 5 percent step-up after seven years. Due to the 2026 deadline, you’d have to invest in 2019 to get full advantage of the 15 percent step-up.
  3. No tax on appreciation. If you remain in the fund for at least 10 years, the capital gains tax is eliminated on the future sale of the investment. Essentially, the cost basis of the property becomes equal to the fair market value on the date of the sale. You do still have to pay the deferred taxes on your original investment.

Example Scenario

Imagine you realize $250,000 in capital gains in 2019. If you roll those gains into an Opportunity Zone Fund within 180 days, none of those gains are taxable this year. After five years, you’ll earn $25,000 in stepped-up tax basis in the fund (10 percent of $250,000). After two more years, you’ll earn another $12,500 of stepped-up basis. At a 23.8 percent tax rate, that’s nearly $9,000 in tax savings.

Now, let’s say you waited until 2029 to sell the investment at an appreciated value of $450,000 (roughly 6 percent annual rate of return.) You’d have $200,000 in gain that would not be taxable. However, you’d still have phantom income on your original $250,000 invest- ment (minus the 15 percent reduction), in 2026 when, per program deadlines, the deferred gain had to be recognized.

In total, that yields approximately $56,600 in tax savings over 10 years ($9,000 in capital gains deduction and $47,600 in capital gains tax eliminated). Your 10- year net, in this scenario, is just shy of $400,000.

Instead, imagine you’d paid the capital gains tax on that $250,000 in 2019 ($59,500 at 23.8 percent) and then reinvested the remainder ($190,500) at a 6 percent annual return. If you sold the investment at the end of 10 years (at a value of $341,000) and paid capital gains taxes again ($35,700), you would net just over $300,000.

Summary

If you have questions about this new investment and whether it would be a prudent part of your wealth management plan, reach out to your estate planning attorney. Be sure you understand the investment risks involved.

Just like other investments, the fund may increase or decrease in value. Due diligence is essential when choosing funds, especially because this is a new incentive program.

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