Way back in 2017, the Tax Cuts and Jobs Act established a brand new program to encourage investment into economically disadvantaged communities. This program, called the Qualified Opportunity Zone program, offered real tax incentives for investors through potentially deferred gains, a step up in basis, and tax-free growth. At the outset, investors with large realized capital gains were given the opportunity to reinvest and potentially save more by holding onto their investment longer; but with the capital gains tax deferral deadline coming up on December 31, 2026, can it still make sense to look at Opportunity Zones for tax savings?

The first step in answering this question is to understand what is a Qualified Opportunity Zone and how investors interact with them. In order for an area to be designated as an Opportunity Zone, a state must nominate that community, and it must then be certified by the U.S. Treasury. Once an area is certified, it can be included within the holdings of a Qualified Opportunity Fund, and this is how most people interact with Qualified Opportunity Zones. These funds operate very similar to any other mutual fund. However, they are required to have at least 90% of their assets comprised of Qualified Opportunity Zone assets, and there are further requirements to make improvements to those properties.

What are the benefits of a Qualified Opportunity Zone?

When this program was first created, the idea was that investors could realize large capital gains from any source, reinvest those gains in a Qualified Opportunity Fund, and get a step-up in cost basis for holding their investment for a designated amount of time. After five years, the investor would get a 10% step-up, and after seven years, the investor would get a 15% step-up. The caveat was that the deadline for this holding period is December 31, 2026. So, in order to take advantage of this tax incentive, you would have had to invest in a Qualified Opportunity fund by December 30, 2021. However, there are still very real incentives for new investment into Qualified Opportunity Funds.

While there is no longer any opportunity to reduce the tax liability, investors can still defer the tax liability on gains taken now until the 2026 tax year by reinvesting gains into a Qualified Opportunity Fund. While this is not a huge amount of time, it may allow investors to push that tax bill to a year that would be more convenient.

Finally, the largest benefit still available to new investors is tax-free growth. Investors that hold their Opportunity Fund investment for at least 10 years do not have to pay taxes on any gains within the fund. Of course, the return numbers are extremely variable depending on the specific fund chosen, but many are seeing positive returns for investors. This could be a great way to achieve tax-free growth outside the traditional methods of using a qualified account or municipal bonds.

Who should consider an Opportunity Zone Fund?

Of course, these funds are not for everyone. They are not suited for investors with most of their assets in qualified accounts or investors that need liquidity from their invested assets. However, for those who are either compelled by the societal benefit of Opportunity Zone investing or the ability to hold the investment for at least 10 years to gain the tax benefit, a Qualified Opportunity Fund may have a place in their portfolio.

As more and more funds are being created, this becomes an increasingly more complex and specialized area of investment. Consulting both a tax and investment advisor to assess the potential benefit as well as your liquidity needs and investment risk should be a crucial part of any potential Opportunity Fund investor’s process. If you have questions about whether a Qualified Opportunity Fund would fit into your financial plan, contact an advisor at McKinley Carter Wealth Services for guidance. Let's start the conversation!

Sources:

• https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions
• https://www.kiplinger.com/real-estate/opportunity-zone-investing-still-hot-despite-looming-sunset
• To see a map of approved Opportunity Zones, click HERE.