qualified opportunity zones

In short

A friend of mine once asked me whether a map could ever change what a person owes in taxes. I told him it could, and he laughed. If you have sold something that grew in value, you may have a tax bill coming, and a qualified opportunity zone is one way the law lets a person delay or shrink part of it. The law is Section 1400Z-2 of the Internal Revenue Code, and the IRS explains it on its Opportunity Zones page. A person with a capital gain puts that gain into a special fund within a set window of days. The fund must put the money into property in a zone the state chose and the Treasury approved. The tax benefit grows the longer the money stays in the fund. The rules are strict, the timing is tight, and a missed step can cost the investor the benefit. A tax professional should look over any plan before a dollar moves.

The whole of it

What it is

I once watched a neighbor drive past a worn out block of storefronts for thirty years and never think twice. Then the town got a grant, and everything changed. That is the spirit behind opportunity zones. Congress created them in 2017 to draw private money into places that had gone without it. Each state governor picked census tracts, which are small areas the Census Bureau uses for counting people, and the Treasury Department approved the list. Those tracts became qualified opportunity zones.

An investor does not buy a building in a zone directly and call it done. The money goes through a qualified opportunity fund. That is a corporation or partnership set up to hold zone property. The fund must keep a set share of its assets in qualified zone property, and the law sets a testing schedule for this. The share is the current figure, which the official source publishes each year, and the IRS explains the test on its Opportunity Zones page. The idea is simple. The investor gets a tax break, and the neighborhood gets the investment.

How it works

You have probably heard that taxes are due when you sell something for more than you paid. That extra money is a capital gain. Say a person sells stock and has a gain. Normally the tax bill comes due that year. With an opportunity fund, the person can put the gain into the fund and defer the tax.

The investor has a set number of days to make that move. The window is the current figure, which the official source publishes each year days, and the clock usually starts on the day the gain is realized. Miss the window, and the deferral is gone. Investors who file Form 8949 and Form 8997 with their return tell the IRS about the investment and track it year to year.

The deferral is the first benefit. The tax on the original gain waits until the investor sells the fund interest or until December 31, the current figure, which the official source publishes each year, whichever comes first. That date is set by law, so it is worth checking the current figure on the IRS page.

The second benefit is about the growth inside the fund. If the investor holds the fund interest for at least ten years, the basis in that interest steps up to its fair market value on the day of sale. Basis means the starting number used to figure a gain. So any growth after the investment can come out free of federal tax. The original gain still gets taxed on the deferral date, but the new growth does not.

The older benefit, a cut in the deferred gain after five or seven years, depended on early investment dates. Those early investment dates were tied to the original law and have been changed by later legislation, so a reader should check the IRS Opportunity Zones page for what applies now.

The numbers, and where to find yours

A neighbor of mine kept her papers in a shoe box, and she was never sorry, because she could always find the one page she needed. Start with three numbers. The first is the amount of your capital gain, which is on the sale paperwork and on Form 1099 B or 1099 S. The second is the date of the sale, because the investment window runs from there. The third is your tax rate on that gain.

The rate on long term capital gains is set by law, and it depends on income. The current brackets are listed on the IRS page for capital gains and losses, and the site shows the current figure, which the official source publishes each year with its source and date. Do not trust a number from an old article. The brackets change.

To find out whether an address sits in a zone, the Treasury and the Community Development Financial Institutions Fund keep a list of designated tracts. The IRS Opportunity Zones page links to it. A tax preparer can also look up a tract by its census number.

A worked example

Let me tell you about a woman I will call Maria Alvarez. She is a retired nurse who sold a rental house in March. She paid $200,000 for it years ago. She sold it for $350,000. Her gain is $350,000 minus $200,000, which is $150,000.

Maria has the current figure, which the official source publishes each year days from the sale to invest. She puts the full $150,000 into a qualified opportunity fund in June, well inside the window. She files Form 8949 and Form 8997 with her return so the IRS knows what she did.

Suppose her federal rate on that gain is 15 percent. Without the fund, she would owe 15 percent of $150,000, which is $22,500 that year. With the fund, she owes none of it that year. The $22,500 is delayed, not erased. She will owe it by the deferral date or when she sells, whichever comes first.

Now say the fund interest grows from $150,000 to $300,000 over eleven years, and Maria sells it. Her growth is $300,000 minus $150,000, which is $150,000. Because she held the interest for more than ten years, her basis steps up to $300,000. So she owes no federal tax on that $150,000 of growth. She does still owe tax on the original $150,000 gain, as the law requires. At the same 15 percent rate, that is $22,500, so the example comes out to the same $22,500 she would have paid at the start. She used the money for years before paying, and she skipped tax on the new growth.

Real tax bills include other items, such as state tax and a possible extra tax on high earners. The example only shows the main idea.

Where it goes wrong

I once knew a fellow who lost a good deal over a form. That tells you how these things go. The most common trouble is timing. The investment window is firm, and a late investment does not qualify. Another trouble is putting in the wrong money. Only capital gains qualify, not wages or a plain savings balance.

The fund itself can also fail. If it does not hold enough qualified property, the law imposes a penalty on the fund. The fund also must improve a purchased building, not just buy it. For an existing building, the law requires the fund to put in new money for improvements that equal the building's original cost, within thirty months.

Zone property is real estate and businesses in a tough area. They can lose money. The tax break does not guarantee a profit, and a loss is still a loss. Fees at the fund level can also eat into returns. Read the fund's offering papers closely, and ask about every fee.

Questions to answer before you leave this page

If you are holding a gain right now, do you know the exact date the investment window began? Do you know how much of the money is a capital gain, and how much is not? Have you found out whether the fund you are looking at is a qualified opportunity fund under Section 1400Z-2? Do you know what the fund charges, and who gets paid first when it earns money? Can you afford to leave the money alone for ten years or more? Have you shown the plan to a tax preparer or a licensed professional who can read your full return? And have you checked the IRS Opportunity Zones page for the rules as they stand today?