Investors who want to lower their capital gains taxes should focus on identifying investments in Qualified Opportunity Zones. People who Invest in these areas of the United States can either defer capital gains taxes or avoid paying capital gains taxes if they hold the investment long enough. This article will discuss some of the laws and benefits of investing in qualified opportunity zones and explain how investors can also choose to invest in Opportunity Zone Funds.
Overview of Opportunity Zones
The Tax Cuts and Jobs Act included a new incentive called Opportunity Zones, which provides incentives for people who invest in economically distressed areas in the United States. The United States government created this program to help boost economic activity in undercapitalized areas of the United States and to provide unique opportunities for entrepreneurs and other investors. The government created QOZs in 18 states in 2018, but they are now present in all 50 states.
Opportunity Zones are located in places with lower median household incomes and higher poverty rates. Furthermore, a higher percentage of the population of these areas does not have a high school diploma or a bachelor’s degree, and the unemployment rate is typically higher in these areas. Opportunity zones can help boost the economic potential of these regions by encouraging businesses to create employment opportunities in these areas.
Qualified Opportunity Funds
There are also qualified opportunity funds, which are entities that invest directly in qualified opportunity zones. In order to be classified as a qualified opportunity fund, the fund needs to invest at least 90% of assets invested in qualified opportunity zones.
In order to invest in a QOF, you need to be an accredited investor. Furthermore, many of these funds have initial minimum investments of $25,000 or more. Investing in a QOF can be very beneficial if you want your investment portfolio to have exposure to these areas, but do not want to make a large, concentrated bet on one business and/or area of the United States.
Qualified opportunity funds can be great investments for investors who want diversified exposure to different parts of the United States, and do not want to actively manage a property or a business. Furthermore, these funds can be solid options for individuals who want to invest a smaller amount of money and do not want to invest in an entire property in a qualified opportunity zone.
Where are they located?
Opportunity Zones are located in all fifty states in the United States and are found in economically underdeveloped areas. A list of all of the opportunity zones in the United States can be found here. Some of the cities with the largest amount of opportunity zones include New York, Chicago, Houston, Philadelphia, and Detroit. Moreover, a large number of smaller and mid-sized cities in the United States are planning to take advantage of these incentives to boost economic development.
One important fact to note is that you did not need to live near any of the qualified opportunity zones to invest in these regions. Therefore, you can purchase remote real estate properties for an investment portfolio, or set up a company office in any region, even if you live elsewhere.
Who is it For?
Any investor can participate in these tax incentives if they are willing to invest in real estate or other assets in these qualified zones. Investing in an opportunity zone can be a great move if you are worried about immediate capital gains taxes or want to develop strategies to avoid these taxes in the future.
Example: If you are about to sell an investment property and are worried about the capital gains taxes, you can choose to invest in a qualified opportunity zone to avoid or defer paying capital gains taxes on the proceeds. This can be a solid option for anyone who does not want to use a 1031 exchange and invest in a similar investment property.
Example: If you are worried about laws changing that will increase long-term capital gains taxes for wealthy individuals in the next 2-5 years, you could choose to invest in a qualified opportunity zone now to ensure that you will pay less in capital gains taxes. Doing this can allow you to exit your investments after ten years and not have to pay high capital gains taxes.
Although some investors can take advantage of other tax benefits, like a 1031 exchange, investing in qualified opportunity zones is a clear-cut way to experience tax benefits if you can hold this investment for a decade. Unlike the 1031 exchange, there is no specific law requiring one to invest in a similar type of property.
In many cases, investors could take advantage of both tax benefits if they own multiple properties.
Benefits of Investing in Opportunity Zones
Some of the benefits of investing in opportunity zones include the following:
Avoiding Taxes: You do not have to pay income taxes on any investment made in a qualified opportunity zone, provided that you hold this investment for ten years. Qualified opportunity zones are attractive investments for investors who anticipate they will still be in a high-income tax bracket during the next 10-20 years.
Deferral of Capital Gains Taxes: You can defer capital gains taxes on other investments if you reinvest this money into a qualified opportunity zone. You can defer capital gains taxes until the end of 2026 if you take advantage of this benefit. Doing this can allow someone to wait until they are in a lower tax bracket before recognizing a capital gain.
Tax Reduction: There is also an option for you to pay less in capital gains taxes ( 10%) for investments made before the end of 2021 and held for five years.
Investing in a QOZ is likely the best for entrepreneurs who want to purchase commercial real estate for their business and stay in an area for ten years or longer. However, investors who do not have a long-term commitment to these areas can still take advantage of tax incentives that allow them to defer capital gains.
If you want to take advantage of the tax incentives of opportunity zones it is crucial to plan and to be ready to make the new purchase as soon as possible. If you want to defer a capital gains tax by investing in an opportunity zone, you have 180 days after the time when you realize the gain to invest in a new opportunity zone. Ideally, it is best to have the sale lined up before you sell your first property so that you will be safe even if there are any delays. This 180-day law also applies to qualified opportunity funds.
When you file your taxes, you will need to complete Form 8949 to show that you want to defer the gain because you invested in a qualified opportunity zone. If you already recognized a gain on your tax return, and then invest in a qualified opportunity zone later, you will need to file an amended tax return.
Capital Gains Proposed Changes
There have been many changes to the laws surrounding capital gains taxes in recent years. Some investors are worried that new changes may increase long-term capital gains taxes for individuals in higher tax brackets.
The American Families Plan that Biden proposed may increase long-term capital gains taxes for wealthier individuals in the future, although there have not been significant changes yet. However, investing in a qualified opportunity zone now can be a great way to avoid higher taxes in the future if anything does change in 2026. Dual benefits of Real Estate and QOZs
The Tax Cut Job Act ( TCJA) provided many types of benefits for small business owners, particularly for people who invest in real estate. For example, people who invest in real estate may be able to take advantage of more rapid depreciation, due to changes to MACRS, and may be able to enjoy bonus depreciation for certain upgrades made to their property.If you invest in an opportunity zone, you can enjoy multiple tax benefits, as you can defer or not pay capital gains taxes, and take advantage of depreciation to lower your income taxes every year.
The TCJA has provided many benefits for small business owners and real estate investors already, and investing in a qualified opportunity zone is another way to boost your tax benefits. These opportunity zones have expanded and are now located in major cities across all 50 states in the United States. You can take advantage of these tax benefits by investing in a qualified opportunity zone or qualified opportunity fund.
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This post was written by Sean Allaband