Ever since the Tax Cuts and Jobs Act was passed in 2017, Opportunity Zones have been a hot topic for investors. The Opportunity Zone program provides various tax incentives for long term investment in lower income communities. Here are the top four reasons why you should consider a Qualified Opportunity Fund for your next investment.
Tax Deferral
Capital gains (profit on an investment) tax can be deferred by investing in a Qualified Opportunity Fund (the official name for an Opportunity Zone investment). These taxes can be deferred until the date when the fund closes or December 31, 2026, whichever comes first. This gives investors the ability to invest what would otherwise be tax dollars.
EXAMPLE
If an investor makes a $1,000 profit from the sale of a stock portfolio, he/she would be taxed ~30% (may vary depending on tax bracket) resulting in a net takeaway of $700. If this amount is reinvested and achieves a 10% year-over-year return, the investor makes an additional $427 after five years. Now, if the initial $1,000 profit is invested directly into an Opportunity Zone, the tax is deferred, and the investor makes an additional $610 from the same investment after five years – that’s a 43% higher return!
Tax Reduction
Capital gains invested in a Qualified Opportunity Fund are not permanently tax free; the taxes are only deferred until a later date. However, if the Opportunity Zone investment is held for more than five years, 10% of the initial investment can be taken tax free when the fund is closed. This tax free amount increases to 15% if the investment is held for seven years.
EXAMPLE
Let’s assume an investor invests $1,000 of capital gains from a recent real estate sale into a Qualified Opportunity Fund. If the investor holds the $1,000 in the fund for five years, only $900 will be taxed when the fund dissolves. This is a substantial benefit for investors with large deferred capital gains balances!
Invest From Multiple Sources
Another major benefit of Opportunity Zones is that capital gains from the sale of any asset can be invested and receive the OZ’s tax benefits. Other tax deferred investments are limited to specific investment types, applying to only real estate or securities. A Qualified Opportunity Fund extends its many tax benefits to the capital gains of any investment. This could include a business, real estate, stocks, bonds, options, cars, art, or collectibles. The ability to invest with the proceeds from multiple sources opens the door for many types of investors, widening the appeal of Opportunity Zones.
Tax Elimination
The final, and arguably greatest benefit of investing in an Opportunity Zone, is that all profits from the investment are returned tax free if the investment is held for at least ten years. With long term capital gains taxes ranging up to 20%, this could equate to massive additional returns for investors.
EXAMPLE
If the same $1,000 from earlier is invested in an Opportunity Zone with a 10% year-over-year return, after ten years, the profit from the investment is $1,594. This entire amount is returned to the investor tax free. If the $1,000 is invested in a traditional stock investment, the investor would be taxed 20% on the $1,594 profit or $319 (may vary depending on tax bracket). With the capital gains tax applied, it lowers the investor’s year-over-year return from 10% to 8.5%.
Investing in an Opportunity Zone is a great way to preserve capital and make an impact on a community in need. To learn more about Opportunity Zones, visit the IRS’s website at https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions.
If you have additional inquiries or would like to be added to our investor portal, please email investorrelations@sterling-partners.com.
