J.P. Szafranski, BridgeTower Media Newswires
As most of us begin the annual ritual of compiling income tax material, hoping to avoid the unwelcome surprise of a higher-than-expected final tax bill, let's talk about a new way many taxpayers can reduce tax liability.
The Tax Cuts and Jobs Act of 2017 includes a fascinating new piece of tax policy aimed to incentivize new investments in economically challenged areas, designated as opportunity zones across the United States.
Qualified opportunity zones are census tracts that must have an individual poverty rate of at least 20 percent and median family income no greater than 80 percent of the median in the area. In 2018, essentially within those parameters, governors from each state designated specific opportunity zones, subject to the review and approval of the U.S. Department of Treasury. Former Oklahoma Gov. Mary Fallin designated 117 opportunity zones across the state, including 19 apiece in Tulsa and Oklahoma City.
How exactly do opportunity zones end up attracting new financial resources? Before tackling that key question, let me remind you that nothing we ever write in this column should be considered tax or investment advice. Please consult your own tax professional to understand how opportunity zones may or may not fit within your own unique tax and financial circumstances. Further, the Treasury Department and IRS are still finalizing specific rules and regulations for the inevitable tax complexity and minutia, so things remain a bit in flux, but the big picture is fairly clear.
Taxpayers now have the option to take realized capital gains, which would otherwise be taxable in the year they are realized, and invest them in a qualified opportunity fund, or QOF, which must hold at least 90 percent of its assets in qualified opportunity zone property. The tax due on any such capital gains would be deferred.
QOF investments are similar to the more well-understood 1031 exchange option for real property. However, unlike with 1031 exchanges, opportunity fund investors only need to invest the capital gain portion and are free to redeploy the tax cost basis amount in any fashion they choose. Taxpayers have 180 days from the date of an asset disposition to invest in a QOF in order to defer taxes.
The capital gains tax from the original investment is deferred until the earlier of the sale of the QOF interest or Dec. 31, 2026. If the QOF is held for five years, the tax due on the original gain is reduced by 10 percent. If the QOF is held for at least seven years, then the original capital gain can be reduced by 15 percent instead. Finally, if the QOF is owned for at least 10 years, any capital gain on the QOF itself will be entirely non-taxable.
So, if a taxpayer sticks with his QOF investment for the long-term, he can reduce the tax on his original capital gain by 15 percent and assuming his investment in the QOF is successful, he'll pay no taxes at all on those capital gains. That is a pretty strong incentive.
State and local government officials are understandably excited at the prospects for opportunity zones to spark development in areas sorely in need of fresh capital investment. We will undoubtedly see great success stories, along with stories of struggling investments where blame is placed on opportunity zones for driving a misallocation of capital.
We should also expect stories of outrage at wealthy investors escaping taxation while creating hardship for lower-income folks as gentrification drives them away. Any time a change in tax policy alters incentives for capital, unintended consequences will result. Differing viewpoints and debate are healthy for democracy and to be expected.
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J.P. Szafranski is CEO of Meliora Capital in Tulsa (www.melcapital.com).
Published: Fri, Feb 01, 2019
