• Terry Herr, CFP®, CLU

Get In The Zone - Understanding Opportunity Zones

Get in the Zone – How to defer, reduce and eliminate capital gains tax.

We’re always asked about ways to save money on taxes. Tax should never be the reason to make or not make an investment, but there are several ways an investor can take advantage of the tax code. The 2017 Tax Reduction and Jobs Act created a huge opportunity for anyone facing large capital gains taxes to defer and even eliminate taxation on an investment made in an opportunity zone. The first important date is December 31, 2019. If you have large capital gains in your portfolio, real estate or other investments you’ll want to be proactive about examining your options.

What is an opportunity zone?

The Qualified Opportunity Zone Program is a tax incentive designed to encourage long-term private sector investments in designated communities known as Qualified Opportunity Zones. The program delivers certain tax benefits to investors through investments known as qualified opportunity funds.

  • Qualified Opportunity Zones are designated census tracts (using 2010 census data) throughout the United States that have been selected by State Governors for inclusion in the program.

  • Qualified Opportunity Funds are investment vehicles that invest at least 90% of their assets in qualified businesses or real property located within these designated Qualified Opportunity Zones.

  • Taxpayers with capital gains from the sale of a prior investment may invest those gains within a 180-day period in a qualified opportunity fund and achieve several potential tax benefits.

  • Investments in qualified opportunity funds are intended to help drive real estate development, job creation and overall economic growth in lower income communities.

  • The total land area in the United States represented by QOZs is over 18%*

  • Over 1 Million properties across the United States are believed to be located within a QOZ**

What are the benefits and risks associated with Opportunity Zones?

There is a trio of potential tax benefits:

1) DEFER – an investor can defer paying capital gains income tax by investing some, or all, of their capital gains until December 31, 2026.

2) REDUCE – an investor will receive a step up in basis by either 10% or 15%.

A) 15% step up if you hold the Opportunity Fund investment at least 7 years prior to December 31, 2026. -or-

B) 10% step up if you hold the Opportunity Fund investment at least 5 years prior to December 31, 2026.

In essence, what this means is that if you invest a $100,000 taxable gain prior to December 31, 2019 you will only pay capital gains tax on $85,000 in the period ending December 31, 2026. ($90,000 if the investment is made after December 31, 2019 but before December 31, 2021)

ELIMINATE – Any capital gain/appreciation of your investment in the Qualified Opportunity Zone is ELIMINATED if the investment is held for at least 10 years.

Keep in mind only capital gains can be invested in QOFs making them only appropriate for taxpayers facing large capital gains. These investments range from hotel developments to multi-family apartment complexes. An investor needs to be prepared to remain in the investment for a period of at least 10 years from the date of the last investor. Available QOFs may not necessarily be suitable for an individual’s portfolio and it is important they examine the offering memorandum carefully along with all of the risk factors involved in a QOF investment.

Risk factors include but are not limited to:

  • Limited Liquidity - currently no public market exist, and one may never exist for qualified opportunity zone funds. QOZ Funds are not liquid and generally require a long term hold period of typically 10 years or more.

  • There is no guarantee a particular QOZ fund will meet their investment objectives.

  • Many QOF funds invest in real estate and are subject to various risks including the inability to collect rents, oversupply of space or reduced demand, vacancies, inflation and increased operating costs, adverse changes in laws and regulations applicatble to real estate and changing market conditions.

  • The actual amount and timing of distributions are not guaranteed and may vary. There is no guarantee investors will receive distributions or a return of their capital.

  • QOZ fund programs may suffer adverse consequences as a result of financial difficulties, bankruptcy or insolvency of their tenants.

  • Changes in tax law

Sources and Disclosure: Assumptions: Capital gains from sale: $100,000. Long term capital gains tax rate (Federal+ACA) 23.8%. State tax: 4%, Simple annual return 9%This illustration does not represent any particular QOF investment. It is merely a hypothetical illustration based on the assumptions listed to show the potential tax benefits of in investing in a QOF investment. The tax rates and returns used in the assumption may vary greatly and should not be construed as any results you would achieve in a WOF investment. This information should not be construed as tax advice. Investors should consult their own tax advisors to determine their potential individual benefits in a QOF investment. We use a hypothetical state tax rate of 4%. State taxes vary and calculations will change based on an individual's state of residence. *Economic Innovation Group, 2019 **ESRI, 2018 Risks of investing in Opportunity Zone Funds include, but are not limited to loss of principal, tax law changes, and liquidity.

This document is provided by Herr Capital Management, LLC is educational in nature, is not individualized, and is not intended to serve as the primary basis for your investment, financial or tax-planning decisions.

Herr Capital Management, LLC - Where Prosperity Begins © 312-697-1600 Securities offered through American Portfolios Financial Services, Inc. Member FINRA/SIPC. Investment advisory services offered through Herr Capital Management, LLC, a registered investment advisor independent of American Portfolios Financial Services, Inc. Investment products are not FDIC insured and involve investment risk including the loss of principal invested. Please consult your tax consultant for tax advice.

Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc.(APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors.

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Securities offered through American Portfolios Financial Services, Inc. Member FINRA/SIPC.  Investment advisory services offered through Herr Capital Management, LLC, a registered investment advisor independent of American Portfolios Financial Services, Inc.