Defer Capital Gains with an Investment into a Qualified Opportunity Zone Fund - Details and Strategies

How can I minimize the taxes on the sale of my business? Some of my clients are planning to sell businesses within the next year or so and they, of course, want to find ways to minimize their taxes on the sale. An investment of realized gains into a  Qualified Opportunity Fund (QOF) could help you accomplish that goal. What is a QOF, how does it work, and what are some strategies to consider?
One of my clients, who is looking at potentially close to $10 million in capital gains, wasn't excited about a Qualified Opportunity Fund until we discussed the tax implications and the strategies he could use and then his eyes lit up. Investments into QOF offer a way to defer and potentially even exclude some of the taxes on your realized capital gains. So let's see why you should potentially be excited about this opportunity.

What are Qualified Opportunity Zones?

These are economically distressed areas where the U.S. government would like to encourage investment to spur economic growth. To encourage investment in these areas tax benefits are being offered to investors who by investing in these areas can defer tax on capital gains that they have realized. 
Before you dismiss this opportunity make sure you are considering the whole picture, not just the investment in a QOF but also the potential tax benefits and planning opportunities. 

How does it work?

To qualify for the deferral of your capital gains you must invest your capital gains in a QOF within 180 days of recognizing the gains. The deferral is reported on your tax return on form 8949, and the investment in the QOF must be an equity interest, not a debt interest.
The tax on your realized capital gain can be deferred until the sale or exchange of the investment in the QOF, or until December 31, 2026 at the latest. Additionally some of the tax on the original gain can be excluded if you hold investment in the QOF for a number of years. Here is a quote from an IRS article on this subject:
If a taxpayer holds its QOF investment at least five years, the taxpayer may exclude 10 percent of the original deferred gain. If a taxpayer holds its QOF investment for at least seven years, the taxpayer may exclude an additional five percent of the original deferred gain for a total exclusion of 15 percent of the original deferred gain. 


Think about what you have just read. If you are looking at paying taxes on millions of dollars of capital gains you could defer those taxes by using this opportunity. So instead of paying all of the tax on all the gain this year you could pay tax on only the portion you want to use this year and defer the rest until you use it for another purpose. In affect you could spread out the tax between now and 2026. This could significantly impact your tax brackets for these years with some planning.
In addition if you hold the investment in QOF for five years you can exclude tax on 10% of the original gain. So if you have a ten million dollar gain you could exclude tax on one million of the gain altogether. And if you hold the investment in QOF for seven years you could exclude paying tax on up to 15% of your original gain. 
Also, if you elect to hold the investment in the QOF beyond 2026 you could potentially have a tax free gain on the investment in QOF if you hold it for at least ten years. Here is a quote for the IRS article about this potential benefit:
If the taxpayer holds the investment in the QOF for at least 10 years, the taxpayer may elect to increase its basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged. This may eliminate all or a substantial amount of gain due to appreciation on the QOF investment.

Other things to consider

Of course their are risks associated with this opportunity. These are economically distressed areas so you would need to consider the potential losses from such an investment. You would want to shop around and do your due diligence on any investment. While it could be a challenge to make money on an investment in these areas it could also turn out to be a good investment for you especially if you hold it for ten years or more.

This is a complex subject with many aspects to consider but could be a really good opportunity for you if you expect to realize capital gains. Of course a conversation with me, the CPA Superhero, about your specific circumstances and your plans could be great value to you in a case like this. Feel free to use my contact information below to arrange an appointment for an initial conversation. 

Jeff Haywood, CPA
The CPA Superhero


Be careful when reading about tax law and its application, including my articles, because the wording and definitions are such a challenge and are influenced by writers perspective, specifically his own clients situations that he is mindful of and other situations the writer is not thinking of. The point is talk to your CPA about your situation and circumstances and don't rely on or make conclusions based on articles you read, including articles form, because concepts and definitions are not very clear, and of course, they are subject to change. Now is the time to be having discussions about your situation and developing strategies for you and your business. Again, contact me using my information above to discuss your situation. I help business owners all over the U.S. and in foreign countries with their tax returns.

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