With the passage of the Tax Cuts and Jobs Act, there is a new section on Qualified Opportunity Zones, a tax incentive that encourages investments in low-income communities. Below are the details on the new tax incentive including what it is, how to utilize it and the benefits of making these investments.
What is a Qualified Opportunity Zone?
A Qualified Opportunity Zone is an area designated by the state in a low-income community.
To be considered a low-income community, the area has to abide by the following:
- The poverty rate is at least 20%, OR
- If not located in a metropolitan area, the median family income for the community must not exceed 80% of the statewide median family income, OR
- If located in a metropolitan area, the median family income for the community must not exceed 80% of the greater of the statewide median family income or the metropolitan area median family income
Even if the area within a state doesn’t meet the above guidelines for low-income communities, it can still qualify as a Qualified Opportunity Zone if the following apply:
- It is contiguous, or adjoining, to a low-income community that’s designated as a Qualified Opportunity Zone, AND
- The median family income doesn’t exceed 125% of the median family income of the low-income community in which the area is contiguous to
No more than 5% of areas designated in a state can qualify through the contiguous community test.
Incentives of Investing in Qualified Opportunity Zones
Defer Tax on Capital Gains
Qualified Opportunity Zones provide benefits as investment instruments. Investors can defer tax on capital gains by investing the proceeds from the sale into a Qualified Opportunity Fund within 180 days from the date of disposition. Qualified Opportunity Funds are used to invest in Qualified Opportunity Zones and must hold at least 90% of its assets in Qualified Opportunity Zones.
Step-up in Basis
If a taxpayer holds their interest in the Qualified Opportunity Funds for specified periods of time, they receive a step-up in basis on that investment. If held for at least 5 years, they receive an increase in basis equal to 10% of the deferred capital gain invested in the fund. If the taxpayer holds the investment for another 2 years for a total of 7 years with investments in the fund, they receive an additional 5% increase of the deferred capital gain held in the fund.
If by December 31, 2026 the deferred capital gain is still held in the investment fund and no tax has been paid on that gain, then they are required to recognize the gain on that date and pay taxes. This applies regardless of if they’re going to continue to hold that deferred capital gain in the investment or not. Just because the tax is being paid on that date doesn’t mean that they can’t continue to hold their investment in the fund.
If the taxpayer continues to hold their investment in the fund and holds it for an additional 10 years, then they will receive a step up in basis equal to the fair market value of the interest and will not be taxed on any appreciation in the interest.
Please contact an Anders advisor with any questions regarding Qualified Opportunity Zone investments and how these changes can benefit you.
