When Congress passed the Tax Cuts and Jobs Act of 2017, they provided three major tax breaks for investors in the form of opportunity zones: a temporary capital gains deferral, a basis step-up of previous gains that have been invested, and permanent exclusion of long-term holdings of more than 10 years.
The idea of opportunity zones is to encourage economic development in areas that have been deemed as low-income, undercapitalized, and in need of investment. The final touches to the act weren’t put into place until late 2019, right before the pandemic hit, so it might be a while before the economic benefits begin to be felt, but opportunity zone benefits for investors are ready for those who choose to avail themselves of them. Investors can benefit from three major tax breaks.
Tax Deferrals
Investors can earn a deferral on taxes on previous capital gains. Investors can include existing assets with original capital gains. Any with capital gains will not be taxed until the end of 2026 or whenever the asset is disposed of.
Basis Step-Up of Capital Gains
Any capital gains invested will be given a basis step-up. For those placed in opportunity zones for at least five years, an investor’s basis increases by 10 percent. If the investment is made for at least seven years, the investment will increase by 15 percent.
Exclusion of Taxable Income on New Gains
Investments held for at least 10 years will earn investors an exclusion of taxable income on new gains produced by their investments in opportunity zones.
What Kinds of Gains Are Eligible?
According to the IRS, qualified gains are eligible for tax deferrals through investments in opportunity zones as long as they are included in federal tax returns by Jan 1, 2027. Unrealized capital gains can be in the form of real estate, stocks, and other investments.
A Temporary Deferral
On the opposite end of the permanent exclusion is the temporary deferral, which allows an investor to defer including their gross income a gain derived from the sale or the exchange of property to any unrelated person if it invested in an opportunity zone during the 180-day period starting on the date of the exchange or sale.
The Step-Up in Basis
How an investor benefit from their capital gains reinvestment depends on how long they hold that deferred gain. It starts at 10 percent if that investment is held for at least five years, 15 percent if it is held for seven years.
Permanent Exclusion
Of all the tax benefits for those who invest in opportunity zones, this one is the most powerful since it is aimed at long-term capital gains. When an opportunity zone investment is maintained for at least 10 years, any gains that result are permanently excluded from the capital gains tax.
The tax basis that is claimed for the investment is the fair market value on the date it is exchanged or sold. For this, however, an investor must make what the IRS calls an “affirmative election” for this leverage tax break. This means It must be chosen by enrolling in a 401(k) or similar plan. The IRS does not do this for you.
Anyone who believes that opportunity zones aren’t worth the time or the trouble should rethink the process since investing can result in decades of tax-free returns.