I’m an investor who wants to reinvest my capital gains into a Qualified Opportunity Fund to deter capital gains tax for 10 years. I’ve heard that the deferred gains must be recognized by Dec. 31, 2026. but how will I be able to keep my investment locked in for 10 years unless it's until 2028?
My understanding is you pay the deferred capital gains tax on the property sold prior to the Opportunity Zone investment by the end of 2026, but you may continue to hold the new zone investment beyond that date and continue to accrue appreciation free of tax on the new investment.
The deferred gain is recognized as of the earlier of the date that: One, the interest in the qualified opportunity fund is sold, or, two, Dec. 31, 2026. The amount of gain included in income is the excess of the lesser of the deferred gain or the fair-market value of the investment over the taxpayer's basis in the investment. The taxpayer's initial basis in the qualified opportunity fund is zero. In the case the investment is held for at least five years, the basis of the investment is increased by 10 percent of the deferred gain. If the investment is held for at least seven years, the basis of the investment is increased an additional 5 percent of the deferred gain. If the investment is held for at least 10 years, and, if the taxpayer so elects, the basis of the property is equal to the fair-market value of the investment on the date that the investment is sold or exchanged.
The Tax Cuts and Jobs Act of 2017 (TCJA) created a new tax incentive designed to encourage development and investment in economically distressed communities known as Qualified Opportunity Zones. These zones are nominated by the individual states and then certified by the secretary of the treasury. The intent of these new tax provisions is to spur economic development by providing tax benefits to investors. An investor can temporarily defer tax on his/her gains on the sale of assets by reinvesting in a Qualified Opportunity Fund. These gains are deferred until the earlier of the date on which the Opportunity Zone investment is sold or Dec. 31, 2026. Additionally, if the investor holds the investment for at least 10 years, the appreciation in value of the investment can be excluded from income. The statute providing these new tax benefits raised a myriad of questions which caused paralysis in the creation of QOFs. Then, on Oct. 19, the Treasury Department and the IRS issued proposed regulations and additional guidance regarding these provisions. Questions will continue to surface and the government has stated that they will issue further regulations and guidance in the months ahead. However, with the guidance just released, there should now be enough certainty that we should start seeing an increase in the creation of QOFs. The taxpayer/investor may elect to exclude from gross income any gain on the sale of property if the gain is reinvested in a QOF within 180 days from the date of sale (“gain deferral election”). As stated above, the gain on sale of the property is excluded from gross income until the earlier of the date on which the Opportunity Zone investment is sold or Dec. 31, 2026. However, if the investor holds the investment for at least five years, he/she is entitled to a 10 percent basis increase and for at least 7 years, an additional 5 percent basis increase in the investment, thus reducing the ultimate recognition of the deferred gain. Furthermore, if the value of the investment is greater than the original amount invested, and the “gain deferral election” is made, the gain on the appreciation is not recognized if the investment is held for at least 10 years. In order to exclude the appreciation from gain, the taxpayer must elect to use the fair-market value of the investment on the date of sale as his/her basis in the investment (“fair market value election”). If an investor invests amounts in excess of eligible gains, the investment is treated as two separate investments. In other words, to the extent the investment comes from deferred gains, it will qualify for QOZ benefits. Any additional investment will not qualify for these benefits.
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