You have to timely roll your gains into the project.
Ask A Question
What happens if I don’t get my money invested in actual OZ projects by Dec. 31 this year?
Some say that I have to invest by Dec. 31 to get the maximum tax benefit. Why? Won’t the zones be extended beyond 10 years?
Answers
To get the maximum benefit you have to invest in the QOF by Dec. 31, 2019. This allows you to have a seven-year holding period to get the 15% gain elimination. If you invest in 2020, the gain elimination drops to 10%. The QOF has to invest in the QOZB by Dec. 31, 2019. This prevents imposition of a penalty, which is essentially an interest charge on the deferred tax liability.
The only requirement is that the taxpayers’ deferred gains are invested into a Qualified Opportunity Fund by Dec. 31 to get the full 15% step-up. Assuming the QOF sets up a subsidiary QOZ Business, the investors generally have over three years to actually invest the funds into a real estate or other business venture.
The deferral of the gain will be taxable no later than Dec. 31, 2026. o the extent you invest in a QOF on or before Dec. 31, 2019, the amount of the gain subject to income tax should be reduced by 15%. Investing in a QOF after Dec. 31, 2019, and on or before Dec. 31, 2021, the gain reduction is 10%. Investing in a QOF after 2021, where the gain was generated no later than Dec. 31, 2026, and timely invested in a QOF, results is no gain reduction. You should do some calculations to determine the yield loss of not investing in a QOF by Dec. 31, 2026. Note that the above does not discuss the 10-year benefit.
The holding period for the step-up in basis to 15% is seven years. Because the tax on the qualifying capital gains in a QOZ needs to be paid by Dec. 31, 2016 (e.g., in seven years), the benefit of the step-up in basis to 15% essentially ends this calendar year, unless such period is extended. Note the foregoing answer is not intended to be relied upon as legal advice, and you should meet with a tax professional about your overall financial plan to understand your options.
It's because the deferral on capital gains is until Dec. 31, 2026, at which time you must recognize the original capital gains and pay the tax with the 2026 tax return filing less any amounts that were stepped up for the five-year and seven-year hold. Note the 10% step-up (so you exclude 10% of the original gain when you do pay the tax recognized in 2026) after five years invested in OZF. There is an additional 5% step up after seven years invested. If you invest after Dec. 31, 2019, it's impossible to be invested for seven years by Dec. 31, 2016 (the recognition date).
The benefits for timely investing capital gain in a QOF are: (1) deferral of the capital gain that is rolled over until Dec. 31, 2026; (2) if a QOF investor holds its QOF investment at least five years on or before Dec. 31, 2026, 10% of its rollover gain is eliminated from taxation and if a QOF investor holds its QOF investment at least seven years on or before Dec. 31, 2026, another 5% (for a total of 15%) of its rollover gain is eliminated from taxation; and (3) if a QOF holds its QOF investment for at least 10 years and disposes of that investment on or before Dec. 31, 2047, the QOF investor can elect not to pay tax on the appreciation over its original investment. This means that the last day an investor can obtain the 15% elimination of rollover gain for investing in a QOF is Dec. 31, 2019. If the investor invests after that, the investor still can defer it rollover gain until Dec. 31, 2026, and can eliminate 10% of its rollover gain if it holds its QOF interest for at least five years on or before Dec. 31, 2026, and the investor still is eligible for the 10 year benefit, if the investor holds its QOF interest for at least 10 years. The QOZ rules are intricate and complicated. You should consult with your own tax advisors.
The second tax benefit is the basis step-up you get in your deferred gain until 2026. To get the full 15% allowable basis step-up, you must invest your gain into a fund by Dec. 31, 2019. Any investment after this date will only be eligible for up to 10% of a basis step-up.
There is still plenty of time after Dec. 31, 2019, to benefit from Opportunity Zone benefits. That said, there is one benefit that will no longer be available to investors after the end of 2019: the additional 5% reduction for investment in a QOF of seven years of longer. Because that seven-year period is measured against the end of the deferral period, which is Dec. 31, 2026, only investments made before Dec. 31, 2019, will be qualify. Investments made after that date are still eligible for deferral until the end of 2026, a 10% reduction in tax at the end of the deferral period, and a tax-free sale after a 10+ years. Also, remember that investing in a QOF triggers the start of your hold period rather than purchase of a particular property, so if you have your own QOF you could place recently realized capital gains into that fund prior to Dec. 31, 2019, and be eligible for the full 15% step-up in basis even if its not until early 2020 that you purchase a particular OZ property or business interest.
The deadlines have to do with the QOF's 90% compliance test. There's a safe harbor for new cash that might allow you until Dec. 31 or beyond to invest in QOZP, but it really depends on facts and circumstances. You'll need to consult your advisor to get individualized "dos" and "don'ts," but the duration of the zone designations has nothing to do with your deadline to invest your QOF's cash on hand.
There only a minor tax benefit loss if you don’t invest by Dec. 31 2018. The most important benefit of additional gains on your investment after 10-year being tax-free is still intact. The amount of tax deferred that must be paid back by April 15, 2027, is increased by 5%. Let's take an example of investing a $100,000 capital gain Dec. 31 2018, and only looking at the federal tax. The tax deferral would be $28,000. By Dec. 31 of 2026, seven years would have passed and the basis would be stepped up by 15%. The tax due on April 15, 2017, would be $23,800. Using the same facts for an investment made in 2019, the deferral would still be $28,000. By Dec. 31, 2026, the basis step-up would only be 10%. The tax due on April 15, 2027, would be $25,000. Regardless of when the investment is made, if this investment is held for 10 years and triples in value, the gain of $200,000 would be tax-free. This will save $56,000 in income tax.
In order to obtain the second 5% step-up you need to keep your investment for at least seven years. Nevertheless, there is a statutory mandatory recognition date of Dec. 31, 2026. Therefore , you need to invest by Dec. 31, 2019, to be able to comply with the at least seven-year requirement. You could fail the seven-year mark and still qualify for the exclusion of the appraisal of the investment if you keep it for at least 10 years.
There will be a small reduction in deferral benefits if you enter in 2020.
DISCLAIMER:the information found on this website is intended to be general information; it is not legal or financial advice. Specific legal or financial advice can only be given by a licensed professional with full knowledge of all the facts and circumstances of your particular situation. You should seek consultation with legal and financial experts prior to participating in any aspect relating to Opportunity Zones. Posting a question on this website does not create an attorney-client relationship. All questions you post will be available to the public; do not include confidential information in your question.