Tips To Save On Capital Gain Taxes If You Are A Real Estate Investor

How You Can Alleviate Your Capital Gains Taxes This Years

The new Qualified Opportunity Zone program (QOZ) can help you alleviate gains made from the sale of real estate, stocks, and bonds, artworks, collectibles, and just about any other assets you might have sold.

Defer gains on:

• Sale of artwork
• Sale of Bitcoin and other cryptocurrencies
• Sale of collectibles
• Sale of developed real estate
• Sale of raw land
• Sale of stocks and bonds
• Sale of tangible and intangible assets

Using the QOZ taxpayers who realized capital gains could earn a 10% tax basis increase in their QOF investment in year five and another five percent increase in year seven. This totals out to a permanent tax reduction of 15%, AND, more importantly, gains accrued after the QOF (qualified opportunity fund) is 100% tax-free when sold after the investment was held for ten years.

The most crucial aspect to keep in mind is not to let the grass grow below your feet: you have to reinvest your tax gains in a Qualified Opportunity Fund within 180 days after recognizing the tax gain on the sale.

Deadline To Keep In Mind

If you made any flow-thru capital gains (including net Section 1231 gains) that were re-portable on December 31st, 2018, these had to be reinvested into a QOZ by June 28, 2019.

For capital assets held directly, the deadline for reinvesting non-1231 capital gains would have started on the earlier closing date of the sales. However, for 1231 and K-1 capital gains, the 180-day period begins on December 31, 2019, for calendar year taxpayers. What is more, December 31st, 2019, is the first date investors will be allowed to reinvest their net-1231 and flow-thru capital gains into a QOF. We are still waiting for the publication of the final regulations concerning this.

December 31st is also the deadline for those investors who wish to obtain the 15% tax-free step-up in their QOF investment. If you invest after that, you will be limited to a 10% step-up because you will not meet the seven-year holding period by December 31st, 2026.

It seems unnecessary to invest in an actual replacement property during the 180 days. It seems sufficient to fund merely the QOF within this period. Deploying the investment into the QOZ business property can be done over a period of 37-months or more afterward.

Know Your Testing Criteria

QOFs have to hold at least 90% of their assets in a QOF business property (QOZBP). If you miss this test (semi-annually), you will trigger a six percent penalty, annually.

QOFs are NOT eligible for the 31-month working capital safe harbor, so every QOF will have to establish a QOZB to allow the long-term deployment of their funds.

However, QOZBs are eligible for the working capital safe harbor, and only have to hold an average minimum of 70% of their assets in QOZBP. This is critical for meeting the Qualified Assets test. A QOZB that does not meet the 70-percent test invalidates the QOZB and the QOF, deleting all the OZ benefits. At this point, there are no regulations relating to a correction period for QOZBs.

Establish Your QOZB Entity

As mentioned above, a QOZB must be formed underneath the QOF, and it must be structured as a corporation or a partnership and cannot be a disregarded entity if it wants to obtain the above benefits.

For QOFs formed this year (2019), it is vital to establish a QOZB within six months of certifying the parent as a QOF. The certification date must be on or before the QOF received funds from a qualified investor.

Know Your Testing Dates

Every QOF has to complete a 90-percent asset test twice per year. To pass the test, the QOF has to prove that 90% of its current QOZBP. In year one, the first test falls at the end of the six-months that includes the month of certification. The asset test will also occur at the calendar or fiscal year-end.

The first test will not take funds received during the six months preceding the test date, into consideration; hence, if a fund is certified in June, the first test date will be at the end of November, during which no penalties can be assessed. The second test date for a calendar year entity certified before August will, therefore, be December 31. In year two, the testing dates will always fall on June 30 and December 31st for the calendar year QOFs.

The asset test is documented on IRS Form 8996. This form is also used during year one to self-certify that the QOF was formed to take part in the QOZ program and for the asset testing based on the monthly average ratings.

If the 90-percent test is missed, the penalty will be calculated by multiplying the asset values by the difference between the actual QOZBP percentage and the 90-percent target. The penalty interest rate will be the rate determined by the ORS during the preceding quarter for each calendar quarter.

Invest Your QOF & QOZB Cash Carefully

If your QOF and QOZB holds large amounts of cash, the April 2019 Tranche II Regulations limit the maturity for fixed income instruments to investments with a maturity of 18 months or less – longer maturities are ineligible and will be treated as a non-qualified OZ business property with a five percent limit that may jeopardize passing the 70-percent test.

Develop Your Business Plan

Before the QOZB can treat cash held by the QOZBP as working capital for purposes of the 70% semiannual test, and since QOFs established on June 28, 2019, or before and its related QOZBs have a real testing due date of December 31st, 2019, fund managers have to have a substantive business plan for the QOZB including cash-flow projections ready beforehand.

In Conclusion

Massive amounts of money are flowing into QOFs. Most funds are flowing into real estate, but a growing number of funds are utilizing the OZ program to grow businesses that operate in the OZs. It is precautious to consult tax professionals in respect of compliance with the complex AOZ rules.