As 2023 is now well under way, it’s a good time to take a look at what investing in opportunity zones holds for us in the coming year and beyond.
What Are Opportunity Zones?
The opportunity zone incentive was enacted in 2017 as part of the Tax Cuts and Jobs Act. If you’re not a student of arcane trivia of the inner workings of the U.S. Senate, you may not know that it wasn't passed following the usual path of a bill, which is generally drafted and passed by both the Senate and the House and signed into law by the president. While the Tax Cuts and Jobs Act enjoyed the support of a majority of the Senate, it lacked the magic number of 60 votes to avoid a filibuster.
In such cases, the Senate allows for a budget-related item to pass with a simple majority using a process called budget reconciliation, which requires only the simple majority that was in place for the Tax Cuts and Jobs Act. And so it was that the TCJA became the law of the land in 2017. But because of the process involved, non-budgetary items — like the opportunity zone reporting requirements that were contained in the original draft of both bills — had to be dropped from the Senate bill before it was passed.
Fast-Forward to 2022
Fast-forward to 2022, and the House and Senate drafted a piece of bipartisan legislation that would have accomplished several things, one of which would have been the restoration of the OZ reporting requirements, but also an extension of the deadline of the program’s expiration date, from 2026 to 2028.
Introduced in April as the Opportunity Zones Transparency, Extension and Improvement Act, the bill would also have reinstated the 10% and 15% step-ups in cost basis that expired last year. It also would have removed the opportunity zone designation from some of the higher-income census tracts and replaced them with lower-income tracts, and also modified the definition of qualified opportunity funds (QOFs) to allow for investment from feeder funds.
Would Have, Could Have, Should Have
Would have, could have, should have — unfortunately, the bill failed to come to a vote in 2022, and as the 118th Congress is now in session, hopes are high that it will come back in some form in 2023. A glance at the political realities in our country right now might cast a pall of pessimism over the bill’s chances in the currently divided Congress.
Nevertheless, the bill enjoyed co-sponsors from both parties in both the House and Senate versions in 2022 and would undoubtedly be bipartisan again in a new incarnation.
With the dual benefits of tax incentives for investors, and a flood of potential new investment in areas that sorely need it, there appears to be a good chance that the legislation will eventually move forward. And for all involved, the sooner the better.
Perfect Storm for Investors
The other adverse development in 2022 with regard to opportunity zone investing was the negative performance of investments in general and stocks in particular. Last year represented a perfect storm for investors. There was nowhere to hide from the correction that took out virtually every sector of the stock market, ravaged bonds, destroyed cryptocurrencies and even hobbled housing prices to some degree, though avoiding the full real estate crash that some had feared.
Regardless, the fact is that a market that struggled in so many ways is a market that produced far fewer capital gains. And fewer capital gains, while not necessarily translating into a reduced desire for OZ investments in 2022, poses potential problems moving forward if fears of an imminent recession prove to be true.
So What Should We Expect for 2023 in Opportunity Zones?
As always, the key word here is opportunity.
Whether or not the expired step-ups in basis are restored, whether or not QO funds are extended past their currently planned 2026 expiration, whether or not new legislation (currently under discussion) expands OZ investments to disaster-affected areas, or enacts rolling seven-year periods of tax deferral, or modifies the law to expand investments into existing businesses, the simple fact is that despite a lackluster investing year in 2022, almost $10 billion in new QOZ investments were made last year. This raised the total of new investments since the program began in 2017 to over $100 billion.
For context, the Treasury Department’s stated goal for the projected 10-year life of the program was $100 billion, and it has achieved that goal in half the time it had hoped!
High-net-worth investors, including family offices and registered investment advisers, are clearly aware of the extraordinary benefits offered by the existing federal OZ incentive, namely, the opportunity to defer capital gains taxes indefinitely, or eliminate them entirely, by holding a qualified OZ investment for 10 years.
Capital Gains Tax Deferral
Tax deferment is a powerful and rare incentive, tax elimination is even more so. And while the array of possible legislative adjustments stands to make opportunity zone investing even more valuable in the future, it's impossible to overstate the existing value of capital gains tax deferral to current investors right now.
Don't Take Your Eye Off the Ball
Investors focused on worries of a recession, troubled about the expiration of the short-term step-up benefits in 2022 or concerned about the program’s potential expiration in 2026 are taking their eye off the ball — and missing a unique and extremely valuable chance to defer or even eliminate capital gains taxes on an appreciated investment.
The existing program enjoys broad bipartisan support and is therefore uniquely positioned to be one of a small handful of federal programs that could be extended or even strengthened despite the current polarized political climate. Even if those legislative goals are not realized, however, opportunity zone investing is well situated to offer meaningful tax benefits for at least the next four years to knowledgeable investors.
Let me invite you to my newest masterclass on qualified opportunity zones, in which I cover:
- The rules and regulations of QOZs.
- Opportunity zone case studies.
- Features and benefits of investing in opportunity zones.
- Drawbacks of investing in QOZs.
- When to utilize the QOZ vs. the 1031 exchange.
Daniel C. Goodwin, Provident Wealth Advisors and AAG Capital, Inc. are not attorneys and do not provide legal advice. Nothing in this infographic should be construed as legal or tax advice. An investor would always be advised to seek competent legal and tax counsel for his or her own unique situation and state-specific laws. Visit our website at provident1031.com.
Daniel Goodwin is a Kiplinger's contributor on various financial planning topics and has also been featured in U.S. News and World Report, FOX 26 News, Business Management Daily and BankRate Inc. He is the author of the book Live Smart - Retire Rich and is the Masterclass Instructor of a 1031 DST Masterclass at www.Provident1031.com. Daniel regularly gives back to his community by serving as a mentor at the Sam Houston State University College of Business. He is the Chief Investment Strategist at Provident Wealth Advisors, a Registered Investment Advisory firm in The Woodlands, Texas. Daniel's professional licenses include Series 65, 6, 63 and 22. Daniel’s gift is making the complex simple and encouraging families to take actionable steps today to pursue their financial goals of tomorrow.
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