“Opportunity Zones” are included in the new tax law known as Tax Cuts and Jobs Act of 2017. These zones encourage private sector investment in low-income community businesses which are inside defined census tract lines throughout the United States.
The new tax code allows any taxpayer to defer gains until the earlier of the date on which the opportunity zone investment is sold or December 31, 2026 on the sale of any property to unrelated taxpayers by investing the gain in an Opportunity Fund, which in turn must invest at least 90% of its assets, directly or indirectly, in businesses located in certain low-income communities designated as Opportunity Zones.
In Alabama, there are 158 census tracts that have been selected as Opportunity Zones by Governor Kay Ivey and ADECA. There is at least one Opportunity Zone in each of Alabama’s 67 counties. Check out an interactive map of Alabama’s zones.
Alabama Opportunity Zone Map
Many investors are waiting for more IRS guidance (we are too!), and it makes sense that investors want to feel comfortable that they’re structuring their investments properly. However, here are the general provisions:
Defer an unlimited amount of gain from the sale or exchange of property (from just about any source) and potentially eliminate a portion of the gain and all future appreciation:
- Deferral allowed through December 31, 2026. Reminder – If you still hold the Opportunity Zone investment on December 31, 2026, you will have to report and pay tax on the deferred gain on your 2026 tax return). However, you will receive basis in the investment in an amount equal to the gain reported at that time.
- If you hold the investment for at least 5 years you will receive additional basis equal to 10% of the original deferred gain
- If you hold the investment for at least 7 years you will receive additional basis equal to 5% of the original deferred gain giving you total basis of 15% of the original gain at that time. Therefore, if you sell the investment after holding it 7 years but before December 31, 2026 you will only pay tax on 85% of the original deferred gain plus the gain of future appreciation. If you still hold the property after holding it 7 years on December 26, 2026 you will pay tax on 85% of the original deferred gain on your 2026 tax return, permanently eliminating the tax on 15% of the original deferred gain.
- If you hold the investment for at least 10 years you will receive a new basis in the investment equal to the fair market value of the investment on the date it is sold. Therefore, holding the investment a minimum of 10 years completely eliminates the gain on any future appreciation.
For example, if you defer a $1 million gain by investing it into an Opportunity Zone fund in 2018 and then sell it for $1.5 million in 2024, you will receive basis of $100,000 in the investment ($1 million times 10%) because you held the investment at least 5 years but less than 7. Therefore, you will only be required to report a gain of $1.4 million instead of $1.5 million in 2024. If you held it until 2025 instead before selling it for the same price, you would have received basis of $150,000 and reported a gain of only $1,350,000 since you held it at least 7 years.
However, if you still hold the investment on December 31, 2026, you will have to report a gain of $850,000 on your 2026 tax return as the deferral period expires at that time. The gain report-able on December 31, 2026 is only $850,000 instead of $1 million because you would have held it at least 7 years on that date and have basis of $150,000 in the investment. In addition, you will receive basis of $850,000 in the investment at that time as a result of the gain recognition so your basis in the investment will include the $150,000 basis for holding it at least 7 years plus the $850,000 gain recognized for total basis of $1 million. Therefore, if you sell the investment for the same $1.5 million after December 31, 2026 but before you hold it 10 years, you will only pay tax on the appreciation of $500,000 because you will have basis of $1 million in the investment and have already paid the tax owed on the $850,000 gain.
Once you have held the investment at least 10 years, your basis will become the fair market value on the date it is sold. Thus, if you sell the investment in 2029 for $1.5 million as in our previous example, you will have a zero gain at that time and effectively avoid gain on the $150,000 for holding it at least 7 years and the $500,000 of appreciation while you held the investment. Assuming the same capital gain tax rates as now in 2029, you will have reduced your tax on the $1.5 million dollar gain by $130,000.
If you have any questions, please do not hesitate to reach out to your JMF tax advisor.
There are plenty of questions still to be addressed by the IRS within their guidance which is expected by year end, so be on the lookout for new discussion and updates of this blog post.