What is a Qualified Opportunity Zone?
This is the story of an entrepreneur who deferred 100% of his capital gains tax on the sale of his business.
This blog is for the entrepreneur who owns a business and thinks one day he might sell. One of the unknowns about selling is what to do about the taxes. Today we are going to unpack Qualified Opportunity Zones. The three things you will learn about are what is a qualified opportunity zone, who should consider them, and what tax benefits you will receive.
What is a Qualified Opportunity Zone?
Back in 2017 during the Tax Cuts and Jobs Act the U.S. Treasury and IRS partnered together to find a way to help disadvantaged urban and rural communities. The goal of this program was to create incentives for the private markets to invest in real estate specifically in underdeveloped communities. The roadblock was incentivizing the capital on the sidelines to deploy money into these areas. In order to get money into these programs, they offered large tax benefits for these investors. With this program, the investor received two tax benefits. Those two benefits are a tax deferral opportunity today and a tax-free investment opportunity in the future.
Recap – What is a Qualified Opportunity Zone?
- Investment into real estate for underdeveloped communities.
- An investment that receives special tax treatment for capital gains that happened in the past.
- An investment that receives special tax treatment in the future.
Who should consider investing in a Qualified Opportunity Zone?
A QOZ should be considered for various reasons, but there are three primary reasons to consider a QOZ. The first reason is if you are looking to defer a capital gain event that happened in the past. The second reason is if you are looking for a way to invest tax-free in the future. Lastly, if you are looking to deploy capital into real estate.
Bob owns an HVAC company in Florida and his business was recently sold. He will be receiving a gross amount of $10,000,000 and has been told that he will be subject to capital gains tax. Bob, like many entrepreneurs, is now trying to figure out unique and creative solutions to defer or avoid paying any additional taxes to the government. As we like to say, we want to pay what the government is owed but not leave them a tip. In this transaction, Bob would pay approximately $2,380,000 in federal capital gains tax. Bob is concerned about paying this money in taxes and wants to know if there is a way to defer any of these gains.
One solution Bob can consider is investing in a QOZ. If Bob were to take all $10,000,000 and invest it into a QOZ he would defer 100% of his taxes. He will not defer these taxes indefinitely, but he will be able to invest dollars that would otherwise be paid to the government immediately. Similar to other tax strategies there are important deadlines Bob must abide by. For the QOZ, Bob must make this investment within 180 days of selling his HVAC business. When Bob makes this investment he is deciding on a long-term time frame. Most opportunities have a goal to hold the investment for 10 years. The reason for the long-term time frame is that holding for 10 years allows investors to get a tax benefit in the future.
If Bob chooses to move forward with this QOZ he will defer his taxes until the year 2026. In 2026 he will be required to pay taxes on the original capital gain from the sale of his HVAC business. Also, Bob will avoid taxes on his gain in the QOZ as long as he meets the holding period requirement. This requirement is a 10-year holding period.
Recap – Who should consider a Qualified Opportunity Zone?
- If you have an asset that you are selling that will create a capital gain.
- If you are looking for a way to avoid capital gains tax on a real estate investment.
What are the Tax Benefits of a Qualified Opportunity Zone?
There are two primary tax benefits that you receive with a QOZ. The first is a tax benefit you receive today and the second is a tax benefit you receive in the future. The tax benefit you get today is a 100% tax deferral on the capital gain of the asset you sold. In our story, this is an entrepreneur selling their business. The tax benefit in the future is tax-free growth on your assets in the Qualified Opportunity Zone. To get these tax benefits you have to follow a few specific rules. The first rule is that you must invest the dollars into a QOZ. Next, is that after you sell your business you have 180 days to invest in the QOZ. Last, is that you must hold your investment for 10 years to eliminate taxes on the gains from your QOZ investment.
Tax Benefits Recap:
- You can defer up to 100% of the capital gains on the sale of your business.
- You can eliminate future capital gains.
If you are an Athlete or Entrepreneur that is interested in learning more about how a Qualified Opportunity Zone might fit into your financial plan, contact us below.
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*JL Strategic Wealth offers information on tax and estate planning that is general in nature. Tax and Legal advice are not provided by JL Strategic Wealth. Consult an attorney or tax professional regarding your specific legal or tax situation.