The Tax Cuts and Jobs Act of 2017 (tax reform) made several changes to the tax code impacting both business and individual taxpayers. Some of the more prominent changes included a reduction in the corporate tax rate, new Qualified Business Income (QBI) deduction, expanded depreciation opportunities, and changes to meal and entertainment deductions. For individuals, there was a doubling of the standard deduction, reduction in certain tax brackets, and the elimination of the personal exemption. While these changes reduced overall taxes, they also eliminated many of the planning tools previously available. The good news is in all the changes, tax reform created Qualified Opportunity Zone (QOZ) investments as a new tax-saving opportunity. Taxpayers are able to defer the tax on gains made in the sale of property or assets when invested in a QOZ. To help clients, prospects, and others, Selden Fox has provided a summary of key QOZ points below.
What is a Qualified Opportunity Zone (QOZ)?
A QOZ is an economically distressed area where new investments, meeting specific criteria, may be eligible for preferential tax treatment. QOZs have been selected based on a nomination process managed by each state and submitted to the Treasury Secretary for final selection. There are currently 327 opportunity zones in Illinois with 133 located within the greater Chicagoland area.
What is a Qualified Opportunity Fund (QOF)?
QOF is a fund that invests at least 90% of holdings into businesses or properties within a QOZ. These funds are required to be invested in businesses or activities that help build infrastructure and create economic opportunities. Those who invest in a QOZ through a QOF can defer capital gains taxes into the future, in some cases, paying a significantly lower amount.
Tax Benefits of QOF Investments
The major tax benefit of a QOF investment is the deferral to capital gains tax until December 31, 2026, or whenever the QOF investment is sold. To receive this benefit, a taxpayer must move realized capital gains from the sale of an asset into a QOF within 180 days from the sale date. The deferral of taxes not only reduces tax owed in the years following the sale but also allows them to use funds in a new investment that would have otherwise been paid to the IRS. It is important to note there are additional circumstances under which additional tax saving is available, including:
- 5 Year QOF Investment – If a taxpayer holds a QOF investment for at least five years prior to December 31, 2026, they can reduce the deferred gain liability by 10% through a step-up in basis.
- 7 Year QOF Investment – To sweeten the savings, if a taxpayer holds a QOF investment for an additional two years, they can reduce the deferred gain liability by an additional 5%. This means any taxpayer holding a QOF investment for seven years prior to December 31, 2026, can reduce the deferred gain liability by 15%.
- 10 Year QOF Investment – The biggest tax savings comes when a QOF investment is held for a period of 10 years. When QOF gains earned from QOZ investments are held for a period of 10 years, there is a permanent exclusion from capital gains tax.
As mentioned above, a taxpayer has a maximum of 180 days after the sale of their property or assets to invest in a QOF. It is important to note an investor is not required to live or work within a QOZ to participate in the program. The IRS has provided a list of Frequently Asked Questions (FAQs) and answers for interested taxpayers to review.
Making an investment in an Opportunity Zone offers an important deferral opportunity that companies and individuals need to consider. While some will still benefit from electing a 1031 like-kind exchange, the opportunity available through QOZs is compelling. If you have questions about the information outlined above or need assistance with tax planning or compliance, Selden Fox can help. For additional information call us at 630.954.1400 or click here to contact us. We look forward to speaking with you soon.