Publication: Fort Worth Magazine (https://fwtx.com/magazines)
Publication Date: TBA, 2020
Submittal Request From: Texas Society of CPAs, Fort Worth Chapter – Guest Writer
Article Title: Opportunity Zones – An Opportunity Worth Investing In – Ken Huffman, CPA, Captive Nation
The newly created “Opportunity Zones” (OZs) are creating a lot of buzz in real estate and business communities. Real estate investors are seeing green when they look at Opportunity Zones, and for good reason. Typically, when an investor divests of an appreciated real estate investment, capital gains tax is due on the appreciated value. However, if this property is located in an Opportunity Zone, all the appreciation is 100% tax free if the investment is held for at least ten years.
How did this all get started and where are Opportunity Zones?
Opportunity Zones were created through The Tax Cuts and Jobs Act in 2017 and was rolled out in 2018. The purpose was to incentivize people to invest in economically distressed communities through capital gains tax incentives. Many people have the misconception that Opportunity Zones must be in an area of town you don’t visit after dark. Some are, however many are not. In fact, you would be surprised some of the Opportunity Zones are located in good areas of town including suburban, industrial, downtown and even rural areas. Opportunity Zone designations are nominated by the Chief Executive Officer of the State, then certified by the Secretary of the U.S. Treasury. Much of downtown Detroit is an Opportunity Zone, and this caught the eye of Quicken Loans founder Dan Gilbert who went on a buying spree. Have you stayed in a cabin in Broken Bow, Oklahoma? If so, you have stayed in an Opportunity Zone. Broken Bow is a great example of what being designated an Opportunity Zone can do for the local economy and real estate market. Many people are building houses and cabins in Broken Bow for rental income, and when they sell the property they walk away paying zero capital gains on the property. Now that sounds like a great opportunity to me!
How does investing in an Opportunity Zone work?
Anyone can invest in an Opportunity Zone. Investors create a Qualified Opportunity Fund (QOF). The QOF then invests at least 90% of its assets into property or businesses located within an Opportunity Zone. The process of investing in an Opportunity Zone is surprisingly simple and can be accomplished in just days with minimal costs.
What type of properties can be invested in?
Multi-Family Housing, Hospitality, Self-Storage, Industrial, Office Building, Mining Facilities, Solar, Retail and much more are available for the Opportunity Zone program.
What are the Benefits of Opportunity Zones?
- Deferral of capital gains
- Reduction of deferred gain over time
- Permanent gain exclusion on appreciation of investment
Deferral of Capital Gains: If you have a capital gain from a sale of a business, building, or stock, you can defer paying your capital gains tax by investing in an Opportunity Zone. You can defer paying the capital gain until the investment is sold, or December 31, 2026 whichever comes earlier. If the investment is not sold before December 31, 2026 any remaining deferred gain is recognized at that time. To qualify for this deferral, you must invest some or all of the capital gain in a Qualified Opportunity Fund within 180 days of the sale.
Reduction of Deferred Gain Over Time: Investments that are held for less than 5 years do not receive any reduction and must recognize 100% of their deferred capital gain. However, if you hold the investment in the Opportunity Zone for at least 5 years prior to December 31, 2026, you only have to recognize 90% of the deferred capital gain. That’s a 10% exclusion on your capital gain! Which means for every $100,000 of capital gains, you would only have to pay tax on $90,000, a 10% discount. Investments in Opportunity Zones prior to 2020 could qualify to receive a 15% exclusion if held for seven years.
Permanent Gain Exclusion on Appreciation of Investment: This is the most attractive part of Opportunity Zones. Investments held for at least 10 years receive a 100% permanent tax exclusion on the appreciation of the property. At the sale of the investment, an election is made to receive a stepped up basis in the investment to fair market value. For example, if a person buys a building in an Opportunity Zone for $1 Million, holds it for 10 years, then sells it for $3 Million, the $2 Million gain is 100% tax free. They pay zero capital gains tax. Typically, that gain would result in a capital gain tax bill of up to $400,000. Now that’s some serious savings! Additionally, accelerated depreciation methods can be implemented, saving significant taxes while you own the property. Ordinarily, when you sell the property you would have to adjust for accelerated depreciation. However, you can fully depreciate the property by 100% and you do not have to make any adjustments at the time of sale. This creates even more tax savings!
Leaders in the Opportunity Zone space are also integrating a captive insurance company into the Opportunity Zone investment to cover the risks associated with investing in an Opportunity Zone and further increase the tax savings of their investment property.
If you are looking to defer and pay less capital gains, and eliminate capital gains on a new investment-an Opportunity Zone might just be the right opportunity for you.
Ken Huffman is a CPA and founder of CPA to CPA, Inc. and Captive Nation, Inc., a captive insurance management firm in Fort Worth. He is writing this column on behalf of the Fort Worth CPAs, a regular contributor to Fort Worth Inc. Contact: Ken@CaptiveNation.com or 888-944-5588.