Much like Wilbur the pig from “Charlotte’s Web”, Qualified Opportunity Zone Tax Incentives have been generating a lot of attention. Given their ability to defer gain recognition up to 10 years, and exempt subsequent gains entirely, they should be attracting attention. They also create an incentive for investment in economically distressed areas. While that sounds like a win for everyone, like farmer Zuckerman’s axe, used carelessly, it can injure the user.
From a tax perspective the new law functions in two stages. The first stage involves reinvesting capital gains into a qualifying business or fund. The reinvestment must occur within 180 days of the gain, but only the gain, not the principal, need be reinvested. This allows the gain recognition to be deferred up to ten years. The second stage occurs after ten years. The deferred tax on the original gain comes due, but an election can also be made to step of the basis on the investment in the qualifying business or fund, effectively sheltering the successive gains earned over the prior ten years from tax. That kind of tax benefit can turn a healthy pig into a great big hog ready for market.
However, the qualifying investment needs to be viable on its own. Otherwise, to continue the porcine allusion, it’s just putting lipstick on a pig. Qualifying investments need to have most of their property in Opportunity Zones or be funds of other businesses that do. While a surprising amount of the country is in these zones, they primarily consist of economically depressed regions. There is often a reason these areas are economically distressed, and any business in one needs to be scrutinized closely. Eliminating the tax on a future transaction that results in a loss isn’t a viable strategy. This still could be a big opportunity for a real estate developer, or anyone else already looking to start a project in one of these regions. For an investor primarily looking for a tax shelter, it could be a slaughter with the wrong underlying investment.
There are numerous detailed and complicated requirements for these tax opportunities to apply, particularly with respect to qualifying business. If you would like to discuss how the new Qualified Opportunity Zone Tax Incentives apply to your situation, please feel free to reach out to us for a consultation.
Written by Damien Falato, CPA, MST, CGMA, Tax Director