Qualified Opportunity Zones: What investors should know
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Attracting investment opportunities into the right sectors is a key goal of the U.S. government. However, persuading private corporations and individuals to put their money in more high-risk areas isn’t an easy task, which is why it sometimes requires an incentive that tips the scales in the right direction.
And that’s exactly what the opportunity zones and Biden’s tax reforms aim to accomplish. And because of the far-reaching impact that the opportunity zones can have on various sectors, investors should be aware of the best steps to take to ensure that they are aware of the potential implications for their assets and taxes.
Most notably, the proposal also outlines potential changes in capital gains taxes. But at the same time, investors in the opportunity zones can take advantage of various incentives and tax breaks that could create big opportunities for those who recognize them.
To help you better understand what the qualified opportunity zones mean for investors, let’s look at what they are, how they work, and how exactly you can benefit.
What is an Opportunity Zone?
An opportunity zone, as defined in this instance, is a set of tax incentives that can be applied when investing in disadvantaged communities that need to attract capital. In other words, the program seeks to encourage investment into low-income areas, creating new opportunities for the local communities and solving many socio-economic issues that the region is facing.
Instead of allocating money directly, the government aims to entice private capital to flow into these disadvantaged areas, which could lead to economic growth that’s more sustainable than merely allocating public money. With private capital, the program could help create economic stimulus and jobs that could have a longer-lasting impact in the area.
How does it work?
According to the program’s plan, a taxpayer can utilize the program to get a relevant capital gain tax exemption based on the amount that they invest into a Qualified Opportunity Zone property. That way, they can take advantage of a favorable tax exemption, where they invest in a property that qualifies for the program and can treat their investment as a sort of tax write-off.
This scheme is realized through the Qualified Opportunity Fund, which is an investment vehicle that allows investors to allocate funds to a Qualified Opportunity Zone property and take advantage of the tax breaks that it comes with. You can invest in the improvement and growth of a property and take advantage of the tax benefits, while also creating growth opportunities that can increase the property’s value and facilitate cash flow.
How can investors benefit?
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The program’s goal is to offset some of the increased risks that come with investing in disadvantaged community areas since they typically carry more risk in terms of the returns potential. Some of these risks include liquidity loss, property value decrease, and various business risks.
We can look at a specific example to better understand how it might work. If a taxpayer would sell a business for $5 million, that income would be taxed as a capital gain. However, if they were to invest that entire income through a Qualified Opportunity Fund, none of it would be taxed. And since the current rate for capital gain tax over $445,850 is 20%, that means savings of $1 million just from investing.
And as a bonus, if the investment in opportunity funds is held for at least 10 years, then the appreciation of the capital gains that are gained through the investment opportunity in the program will also not be applicable.
And that allows the taxpayer to be more willing to invest in a riskier venture, knowing that some (if not all) of that risk is offset by the Qualified Opportunity Zone program. At the same time, it facilitates growth and the immediate reinvestment of money that would otherwise have to be invested through government programs.
Bottom line
Qualified Opportunity Zones are an increasingly popular option for taxpayers who want a tax break and a potentially lucrative investment opportunity all in one. However, for the program to work, commitment and patience are key ingredients, as you will need to hold your investment for multiple years if you don’t want to lose the benefit.
While it may not be for every investor, those who receive significant capital gains can take advantage and utilize the benefits that often outweigh the potential risks.