It’s tough to think of a highly appreciated asset as the problem child in a portfolio. The goal is to choose investments that will flourish, after all. And those strong performers are typically the ones you love best and hold onto the longest.
But things can get complicated when it’s time to let go — when that stock stops growing and you’re ready to sell, or when you’re preparing to part with a valuable business or piece of property.
That’s because the federal government likes winners, too — and thanks to capital gains taxes, you could end up sharing a hefty portion of your profit with the IRS.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
But there are strategies that can help.
I’ve written here before about using a 1031 Exchange or a Deferred Sales Trust to defer capital gains taxes when selling real estate. But now a newer strategy is giving the 1031 and DST some competition; it’s called a Qualified Opportunity Zone Fund. And you can use it with any investment that will trigger capital gains.
Like any investment strategy, it comes with risks, and it’s not for everyone. But for those who feel trapped by capital gains, the tax savings and potential for profit make it worth looking into.
What is a Qualified Opportunity Zone Fund?
- Opportunity Zone Funds became part of the tax code with the Tax Cuts and Jobs Act of 2017. The funds are created by partnerships or corporations that invest in eligible properties within designated Opportunity Zones.
- The IRS defines an Opportunity Zone, or O-Zone, as an “economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.” In other words, the communities on the receiving end of these funds hope to benefit from revitalization, while investors can reap tax benefits by putting their money toward those improvements.
- In order to qualify, an Opportunity Zone Fund must invest at least 90% of its capital in O-Zone property.
How does it work for the investor?
- When an investor sells an asset, he or she can roll any amount of the gain into an Opportunity Zone Fund within 180 days of the sale. The investor can then defer capital gains taxes on that amount until Dec. 31, 2026, or until the Opportunity Zone Fund investment is sold or exchanged (whichever comes first).
- An investor who keeps the money in the Opportunity Zone Fund for at least five years can defer payment of capital gains and exclude 10% of the taxable gains from the original amount invested.
- If the investor keeps the money in the fund for at least seven years, he or she can exclude another 5% (for a total of 15%) of the taxable gains from the original amount invested.
- Investors who hold the money in the fund for at least 10 years can exclude 15% of the original amount invested. In addition, any accrued capital gains generated from the investment are 100% tax exempt.
So, let’s say an investor sells an asset and has a $100,000 tax liability. By holding the money in an Opportunity Zone Fund for 10 years, the investor would avoid paying capital gains taxes for a decade, reduce his liability to $85,000, and any gain on the money invested in the fund would be tax-free.
What are the risks?
Because this is a new investment strategy, there are some uncertainties, including:
- The IRS and Department of Treasury are still working on the specifics of how Opportunity Zone Funds will work over time — both for investors and those in charge of the funds. So, you may enter into this investment with questions that can’t be answered just yet. (That doesn’t mean you shouldn’t ask, though.)
- Because the areas earmarked for improvement are distressed, recovery may not go as quickly as planned — and a fund won’t gain in value if the targeted community and its businesses aren’t gaining in value. So, like any investment, there’s no guarantee you’ll make money.
- The tax plan is currently set to sunset on Dec. 31, 2026. If it isn’t extended, investors would be required to begin paying taxes on accrued capital gains after this date, regardless of how long they hold on to the fund as an investment.
Did I mention that this isn’t for everybody? As a matter of fact, you must be an “accredited” investor in order to participate, meaning investors who have a net worth exceeding $1 million and/or an annual income exceeding $200,000 individually or $300,000 for joint households.
However, it can be an appealing alternative for those who want to diversify, who might like the idea of an investment with social impact or are seeking a long-term investment with tax benefits.
If you think it could be a fit with your overall financial plan, be sure to discuss the pros and cons with your tax or financial professional. Ask for a comparison of the benefits of investing in Opportunity Zones vs. a 1031 Exchange or Deferred Sales Trust. And talk about the funds available and how to choose the right one.
Currently, the number of funds is limited, but once the Treasury Department finalizes its regulations, you can expect to see more — and more investor interest.
Kim Franke-Folstad contributed to this article.
This material is for informational purposes only. It is not intended to provide tax, accounting or legal advice or to serve as the basis for any financial decisions. Individuals are advised to consult with their own accountant and/or attorney regarding all tax, accounting and legal matters. Securities offered only by duly registered individuals through Madison Avenue Securities, LLC (MAS), member FINRA/SIPC. Advisory services offered only by duly registered individuals through Global Wealth Management Investment Advisory (GWM), a Registered Investment Advisor. MAS and GWM are not affiliated entities. For accredited investors only.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
-
Donating Complex Assets Doesn't Have to Be ComplicatedIf you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Travel trends you can expect this summerThe Kiplinger Letter Domestic trips will trump foreign travel amid economic uncertainties, though some costs are down.
-
Donating Complex Assets Doesn't Have to Be Complicated
If you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Think a Repeal of the Estate Tax Wouldn't Affect You? WrongThe wording of any law that repeals or otherwise changes the federal estate tax could have an impact on all of us. Here's what you need to know, courtesy of an estate planning and tax attorney.
-
In Your 50s? We Need to Talk About Long-Term CareMany people don't like thinking about long-term care, but most people will need it. This financial professional recommends planning for these costs as early as possible to avoid stress later.
-
Social Security Pop Quiz: Are You Among the 89% of Americans Who'd Fail?Shockingly few people have any clue what their Social Security benefits could be. This financial adviser notes it's essential to understand that info and when it might be best to access your benefits.
-
Such Attractive Yields in High-Grade Munis Are Rare and May Not Last LongAccording to this munis expert, the last time munis were this cheap was a brief period in 2023. If you kicked yourself for missing out then, you have a second chance now.
-
Financial Analyst Sees a Bright Present for Municipal Bond InvestorsHigh-tax-bracket investors have an excellent opportunity to secure low-volatility, high-quality returns at yield levels rarely seen in over a decade.
-
I'm an Insurance Pro: How Not to Get Dumped by Your Insurance AgentYour insurance agent or broker might show you the door if you do any of these five things. Being a good customer is about more than paying your bill on time.
-
Two Estate Planning Issues You Should Never OverlookThis estate planning attorney explains why proper asset titling and beneficiary designations make a big difference when it's time to transfer your wealth.
