Qualified Opportunity Zones & Qualified funds to defer your gain

[Ashish Acharya]

I was doing a research for a customer and realized Bp community can also benefit from this. I personally believe, Qualified Opportunity zones almost as effective as 1031 exchange.  Trying to keep this simple and just the basics.  We are still waiting on some technical correction and clarification. 

The Tax Cuts and Jobs Act allows

A) Temporary deferral of inclusion in gross income for capital gains reinvested in a Qualified Opportunity Fund (QO Fund) and

B) Permanent exclusion of certain capital gains from the sale or exchange of an investment in the QO Fund.

A) Temporary deferral of inclusion in gross income for capital gains reinvested in a Qualified Opportunity Fund (QO Fund) 

Important points:

● No dollar limits

● Have to reinvest the capital gain within the 180 days

Have to include the excluded gain (reinvested gain) at the end of the deferral period which includes earlier of:

○ The date on which the investment is sold

○ Dec 31. 2026

● What gain is included? See example below.

○ Excess of (formula = Initial reinvested gain – basis of investment)

■ Gain excluded when reinvested in QO fund (or FMV of investment if lower) over

■ Basis in the investment.

○ Basis starts with Zero and increases in this order

■ Held for 5 years - 10% of gain reinvested

■ Held for 7 years - 15% of gain reinvested

■ Held for 10 years - 100% of gain reinvested

Thus, if held for 10-year, total capital gain that was reinvested is permanently deferred.

B) Permanent exclusion of certain capital gains from the sale or exchange of an investment in the QO Fund.

● If the investment is held for 10 years, the capital gain on the sale of the investment is excluded.

What is QO fund:

Corporation or partnership that invests in QO zone property that holds 90% of its asset in the QO zone.

A QO Zone property is property is:

● Domestic Stock

● Partnership interest

● Business property used in trade or business

Example:

A sells a property and realizes a gain of $1 million on Dec. 1, 2021. On Dec. 31, 2021 (i.e., a date within the 180-day period beginning on Dec. 1, 2021), A invests all of the $1 million gains in a QO Fund. If A makes the temporary deferral election, A does not include the $1 million of realized gain in his gross income for the 2021 tax year.

If A holds (Not sold) the investment in the QO Fund until Dec. 31, 2026, as the deferral period is over, A has to include the deferred gain in A’s gross income in 2026.

How much of the reinvested $1M would he include? Answer: 900,000

● Reinvestment amount = $1M

● Basis increase = 100,000 (10% of Reinvestment as held for 5 years.)

● Gain included = (Reinvested amount - basis increase) = 1M - 100,000= $900,000.

If A also sells the investment in QO Fund on Dec 1, 2031, 10 years later, he does not recognize any capital gain on the sale of his investment in QO fund.

If A sells the investment before 10 years, basis in the investment is based on the time it is sold:

Basis starts with Zero and increases in this order

■ Held for 5 years - 10% of gain reinvested

■ Held for 7 years - 15% of gain reinvested

Basis at 5 years = 100,000

Basis at 7 years = 150,000

Thus gain/loss is determined based on the FMV of the investment less the basis at the date of sale. If a date of sale was more than 10 later the initial investment, no capital gain is recognized.