There’s a familiar phrase that says there’s only two things in life you can be certain of: death and taxes.
But what if there was a legal way to avoid at least some of those taxes?
Under the relatively new Tax Cuts and Jobs Act, there’s a provision that may allow you to do just that for the tax on capital gains for some business and real estate investments. It’s through an incentive called Opportunity Zones, and some people are calling them “the biggest tax break of our lifetime,” according to an April article in Realtor Magazine quoting Tiffany Lewis, a broker who works with residential property investors.
This article will explain a little about what Opportunity Zones are, how they work and how they can benefit real estate investors.
When real estate investors sell property, they typically either pay taxes on their capital gain (the increase in the value of their investment) or defer taxes through a 1031 exchange (selling one property and replacing it with the purchase of another property).
Let’s say you sold a rental property for $300,000, paid $200,000 originally and didn’t make any improvements. For simplicity’s sake, let’s say you have a taxable gain of $100,000.
Rather than pay the full capital gains tax on the $100,000, Opportunity Zones help you decrease that bill. In fact, the concept of Opportunity Zones helps investors in three distinct ways.
First, you can reinvest your capital gain into an Opportunity Zone project and avoid paying taxes on the gain until 2026 or until you’re no longer involved in the Opportunity Zone investment. That’s like an interest-free loan from the IRS.
Second, if you keep your investment in the Opportunity Zone for five years, you get to decrease your taxable gain by 10 percent. If you invest the money for seven years in the zone, the 10 percent increases to 15 percent. That means you only pay taxes on 85 percent of your original capital gain.
Finally, if you make money on your Opportunity Zone investment and you hold it for at least 10 years, you never pay capital gains tax. Keep in mind, however, that you still have to pay taxes on 85 percent of your original capital gain that came from another project. You also pay taxes on any operating income the investment produces.
To receive these tax benefits, you must reinvest your capital gain in a Qualified Opportunity Fund within 180 days of the sale of the asset. Opportunity funds represent money investors have pooled together to acquire and improve properties in Opportunity Zones.
Investors can work with an existing fund or put money into their own fund. Just make sure to work with your tax and legal advisor to make sure everything is set up correctly. To find a directory of opportunity funds, visit http://ncsha.org.
Unlike a 1031 exchange, Opportunity Zone investments don’t need an intermediary to hold your funds before you reinvest them. Also different from a 1031 exchange is the fact that you only need to reinvest the gain, rather than the entire proceeds from the sale.
Together, these provisions provide significant tax savings for investors. So why is the government willing to provide such big tax breaks?
Opportunity Zones are economically distressed communities. The goal is to incentivize investment in underserved, low-income areas that could use additional capital and jobs. In Northern Utah, there are Opportunity Zones in specified areas in Clearfield, Layton, Downtown Ogden, South Ogden, Brigham City, Tremonton and Logan.
Opportunity Zones also provide another benefit to those who own property within them. Because the Opportunity Zones offer such great tax benefits, owners who once had difficulty selling their property may be able to find new interest and realize higher-than-expected prices from potential buyers.
To learn more about how Opportunity Zones could help you, make sure to talk to your Realtor, tax advisor and attorney.