opportunity zones

In short

A friend of mine once sold a rental house and stared at the tax bill like it was a letter from a stranger. If you are holding a gain from selling stock, land, or a business, opportunity zones are one rule set that lets a person put that gain to work in a certain kind of fund and change the timing of the tax. The gain goes into a qualified opportunity fund within a window of days that the law sets, and the fund must hold its assets in designated census tracts. The tax on the original gain can be pushed out to a set date in the law, and gains made inside the fund can be treated well after a long hold. None of this is free money, though. It comes with deadlines, paperwork, and the risks of the investment itself. Talk with a licensed tax professional before moving a dollar.

The whole of it

What it is

I once watched a neighbor wait all summer for a road crew to pave the street outside his shop. He figured, fairly, that a little push from the town would bring in business. Opportunity zones come from a similar hope. Congress created them in the Tax Cuts and Jobs Act of 2017. States nominated low income census tracts, and the Treasury Department certified them. Those tracts are the designated opportunity zones. The idea is to draw private money into places that have gone without it.

An investor does not buy a zone directly. Money goes into a qualified opportunity fund, which is a corporation or partnership that holds at least the current figure, which the official source publishes each year of its assets in qualified opportunity zone property. The fund may buy real estate, or it may own a business that operates inside a zone. A fund that fails the asset test can owe a penalty, and the Internal Revenue Code sets how that penalty is figured.

You have probably heard that this program is only for the wealthy. It is open to anyone with an eligible capital gain, whether the gain is big or small. The gain can come from stock, a business sale, or a property sale. The size of the gain decides how much tax is at stake, and nothing else.

How it works

If you are thinking about a gain you already have, the clock matters most. The law sets a window of the current figure, which the official source publishes each year days, counted from the date the gain arises, for putting that gain into a fund. Special cases, such as a gain that passes through a partnership, can change how the days are counted. The IRS instructions for Form 8997 and Internal Revenue Code section 1400Z-2 are where a tax professional would check the details.

Once the gain goes in, the tax on that original gain is deferred. The law sets a date when the deferral ends, and that date is the current figure, which the official source publishes each year. On that date the investor must report the deferred gain, even if the fund investment has not been sold. Some folks miss this and are surprised by a bill for money they never saw land in their pocket. Mark it.

The second benefit comes from a long hold. If the investor keeps the fund interest for at least the current figure, which the official source publishes each year years, the gain earned inside the fund can be excluded from tax when the interest is sold. The original gain is not excluded in that case. Only the growth after the investment is. The 2017 law once offered a basis step up that cut the deferred gain, but Congress changed the rules, so Internal Revenue Code section 1400Z-2 is the place that spells out what applies today.

The fund reports to the IRS on Form 8996, which is attached to its annual return. The investor reports the deferral on Form 8949 and Form 8997. Those forms are the paper trail. Keep copies.

The numbers, and where to find yours

Four numbers drive the whole thing. The first is the number of days to invest a gain, which is the current figure, which the official source publishes each year. The second is the asset test for the fund, which is the current figure, which the official source publishes each year. The third is the long hold period for the growth exclusion, which is the current figure, which the official source publishes each year years. The fourth is the deferral end date, which is the current figure, which the official source publishes each year.

To find your own numbers, start with the date your gain arose and count forward on a calendar. Then find your capital gain on Form 8949 and Schedule D from your return. The fund will give you its own figures in its offering papers. You can check whether an address sits inside a zone by using the census tract maps the Treasury Department's CDFI Fund publishes. IRS Form 8997 and its instructions list what the investor tracks each year. Internal Revenue Code section 1400Z-2 is the primary source for the rules themselves.

A worked example

Take a woman named Dolores. She sold shares of a company she had held for years. She paid $40,000 for them and sold them for $100,000. Her gain was $100,000 minus $40,000, which is $60,000.

Dolores wanted to try the opportunity zone route. Within the window the law sets, she put the $60,000 gain into a qualified opportunity fund. She did not need to put in the whole $100,000 sale price. Only the gain counts for deferral. The other $40,000 was her original cost, and that stayed hers.

Say her federal capital gains rate was 15 percent, which is her own figure for this story and not a legal limit. The tax she would have owed that year was $60,000 times 15 percent, which is $9,000. By investing the gain in the fund, she deferred that $9,000 until the deferral date in the law. She kept $9,000 working instead of sending it to the IRS right away.

Now picture the fund doing well. Her $60,000 grows to $110,000 after more than the long hold period. The growth is $110,000 minus $60,000, which is $50,000. If she meets the hold rule, that $50,000 can be excluded from tax when she sells. At her 15 percent rate, that would have been $50,000 times 15 percent, or a $7,500 tax bill, and it is gone.

But on the deferral date, she still reports the original $60,000 gain and pays tax on it. That is $60,000 times 15 percent, or $9,000. She does not get that part back. The savings are the delay on the first gain and the exclusion on the growth.

Now picture the fund doing poorly. Her $60,000 shrinks to $45,000. She still owes tax on the original $60,000 gain on the deferral date, subject to how the law treats the fund interest. A loss in the fund does not erase the old gain. That sting is real.

Where it goes wrong

I have noticed that good news travels faster than the fine print. The first trap is the clock. The law sets a window for investing the gain, and a gain that misses it does not qualify for the deferral. There is no gentle second chance.

The second trap is the fund itself. A tax break does not make a weak investment strong. A fund can lose money, charge fees, or hold property that sits empty. The tax rules only change the timing and the rate. They do not guard the principal.

The third trap is the asset test. A fund that falls short of the current figure, which the official source publishes each year can owe a penalty, and the investor may lose some of the benefit. The investor should read how the fund tests itself and how often.

The fourth trap is the paperwork. The fund must file Form 8996. The investor must file Form 8997 each year the interest is held. A skipped form can cause trouble later. Wrong tracts are a fifth trap. A property one block outside the map does not count, so the tract must be checked against the official list.

Last, the deferral date arrives whether the investor is ready or not. The tax on the original gain comes due, and the investor will want cash on hand for it. That is plain.

Questions to answer before you leave this page

When did your gain arise, and have you counted the full window of the current figure, which the official source publishes each year days forward on a real calendar? Is your gain a capital gain that qualifies, and have you found the exact figure on Form 8949? Does the fund hold at least the current figure, which the official source publishes each year of its assets in zone property, and how does it prove that? Can you leave your money in for the current figure, which the official source publishes each year years if you need to, and what would you do if you needed it sooner? Will you have cash ready for the tax that comes due on the current figure, which the official source publishes each year? Have you read the fund's offering papers for fees, risks, and who runs it? And have you asked a licensed tax professional to look at your own numbers before you decide?