The Opportunity Zone program – part of 2017’s Tax Cuts and Jobs Act – ushered in a new set of compelling tax incentives for real estate investments into historically under-invested communities – the 8,700+ ratified Qualified Opportunity Zones (QOZ) throughout the country. EquityMultiple allows individual investors to access professionally vetted and managed, high-quality commercial real estate projects structured to provide these tax benefits at relatively low minimums. The program offers the potential to substantially enhance post-tax returns when the program requirements are followed.
Opportunity Zone Tax Benefits: A Quick Recap
In short, Qualified Opportunity Zone investments allow for the deferral, reduction, and elimination of capital gains tax. To receive these benefits investors must invest capital gains derived from other investments, and to maximize the benefits they must hold the investment for 10+ years.
For a comprehensive breakdown of the mechanics of the QOZ program tax incentives, please refer to our resource page on the topic)
What December 31st, 2019 means for Opportunity Zone Investing
As 2019 draws to a close, we want to emphasize a time-sensitive component of the tax benefits that may materially impact your QOZ investing plans.
As noted above, the program provides for a step-up in basis for investments held for five years, and an additional step-up in basis for those held for seven years, for investments made prior to December 31st, 2026. So in order to maximize the tax benefits afforded by the program, December 31, 2019 is the last day on which investors can complete a Qualified Opportunity Zone investment and hold it for a full 7 years. In other words, this coming New Year’s Eve is the last day to roll over pre-existing capital gains into a QOZ fund (QOF) and achieve a 15% reduction in tax owed on those capital gains.
Please note that the Opportunity Zone program tax benefits remain compelling for investments completed after 2019, particularly if completed before 2021. Investors can benefit from both the deferral on paying capital gains tax and the elimination of new federal capital gains on the QOZ investment. Investors will, however, only be eligible for a 10% reduction in their capital gain tax liability, rather than 15%
As a hypothetical example, assuming an investor is in the highest federal long term capital gains tax bracket (23.8%), the total capital gains tax on $1M would be $238K.
With the QOZ tax incentive for a seven-year hold, however, the investor would pay a capital gains tax on only $850K resulting in savings of more than $35K on their tax bill.
If the investor waited until after December 31, 2019, to invest their $1M capital gain into a QOF, at the end of seven years, the investor would pay tax on $900K. A potential one-day delay results in a decreased tax benefit to an investor of nearly $12K.
Investors are clearly taking notice of this upcoming deadline. Novogradac, a national accounting and consulting firm that tracks QOF investment, reported in early December that nearly $4.5 billion had been raised for QOFs seeking third-party investors; a 40% increase from their prior survey, in October 2019.
2019 K-1 Capital Gains & QOZ Investing
For investors who earned passthrough partnership capital gains in 2019, December 31 is significant for another reason. Partnership members have 180 days to invest into a QOF from i) December 31st of the year the partnership incurred the gain or ii) at their election, 180 days from the day the partnership recognized such gain. Here’s an example of how this works in practice:
- A owns an interest in AB LP. AB LP is a calendar year partnership that generates a long-term capital gain from selling stock held for investment on Feb. 1, 2019. AB LP distributes the sales proceeds to the partners rather than investing in a QOF. Because AB LP did not reinvest the gain in a QOF, it will pass the capital gain through to its partners on Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc.
- A can elect to defer her share of AB LP’s gain by investing the gain in a QOF during the 180-day period beginning on the last day of AB LP’s tax year, Dec. 31, 2019. Alternatively, A can use the elective rule to use the partnership’s 180-day period. In that case, A can elect to defer her share of AB LP’s gain by investing the gain in an opportunity zone fund during the 180-day period beginning on Feb. 1, 2019. If AB LP had not distributed the proceeds, A could use cash from other sources to invest in the QOF and defer the gain.
This makes December 31, 2019 a unique date for certain investors – it is the first day they can invest their 2019 capital gains and the last day to maximize the QOF tax benefits. 1
How do I alert the IRS that my capital gains were deployed into a QOF??
Individual taxpayers will report capital gain on Form 8949 and Schedule D Form 1040. Form 8949 is a federal tax form that was in use prior to the Opportunity Zone rules and is used to report sales of capital assets such as stock. There have been no changes to these forms from 2018 to 2019. If you invest your gains into a QOF, your tax preparer will use form 8949 to report the investment by entering code Z in column (f). By making this submission the IRS knows you are deferring your gain.
Maintain Focus on Quality Investments
The tax incentives afforded under the Opportunity Zone program were created to rapidly spur capital flows to underserved communities, hence the time-sensitive nature of the tax reduction incentives. All investors should properly consider investment opportunities, and whether they align with your liquidity requirements and overall risk strategy. However, to maximize the tax benefits, December 31, 2019 is a critical date.
At EquityMultiple, our approach has always been to only pursue projects that are attractive on their face, irrespective of Opportunity Zone qualification. A recent MIT report found that tax benefits have already been priced into properties within Qualified Opportunity Zones, with assets trading at a premium relative to non-eligible assets. This lends further credence to our approach of thoroughly evaluating the sponsor and market, and examining the going-in cost basis, absent of any potential enhancements to post-tax returns.
If you are considering an EquityMultiple QOZ investment before year-end, our dedicated Investor Relations team is ready to address any of your questions. Please feel free to reach out at any time by emailing us at firstname.lastname@example.org or scheduling a call.
Disclaimer: It is important to note that EquityMultiple does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax or accounting advice. Your tax situation is unique and you should consult your own accounting advisor before engaging in any transaction.
Disclosure: Securities offered through Growth Capital Services (member FINRA, SIPC) 582 Market Street, Suite 300, San Francisco, CA 94104. Any Interested Party will be responsible for conducting their own investigations and analysis. Neither Growth Capital Services, nor any of their respective representatives makes any representation, warranty or guaranty of any kind, express or implied, as to the accuracy, completeness or reasonableness of the information contained herein or any other written or oral communication transmitted or made available to any Interested Party. Growth Capital Services, and their respective affiliates expressly disclaims any and all liability based on or arising from, in whole or in part, such information, errors therein or omission there from. Only those representations and warranties that are made in a definitive written agreement relating to a transaction, when and if executed, and subject to any limitations and restrictions as may be specified in such definitive agreement, shall have any legal effect. Any past performance information provided is no guarantee of future results. All investments involve risk including the potential for loss of all capital invested. Any Interested Party must be able to bear such risk and must either possess the necessary financial and business knowledge and experience to evaluate the merits of this investment or consult with a competent investment professional prior to making any investment decision.