Opportunity Zones
HOUSTON OPPORTUNITY ZONE FUND GUIDE
- Overview
- Formation
- Capital Gain Deferral
- Basis Step-Up
- Capital Gain Exclusion
- Timeline [Example]
- Example Economics & Comparisons
OPPORTUNITY ZONES TAX BENEFITS SIMPLIFIED
Investing in Opportunity Zones happens through qualified Opportunity Funds (O-Funds), the designated O-Zone
investment vehicles. The main Opportunity Zones Tax Benefits are:
Deferred Capital Gains Tax – You can sell current assets to invest taxable capital gains into O-Funds. Do this within 180 days of selling your assets and you avoid paying capital gains tax (at least until an O-Fund is divested or until December 31, 2026).
Basis Step-Ups – Basis step-ups increase your rolled-over capital gains: A five-year O-Funds holding brings a 10% basis step-up. A seven-year O-Funds holding brings an additional 5% (15% total).
Fewer Limits – Finally, there are fewer limits on O-Fund investments. There are no limits on the amount invested, the type of taxes you avoid, how much tax you avoid, and the amount of time that gains can compound tax-free.
Tax-Exempt Potential – Holding O-Funds investment for at least 10 years lets them grow tax-free AND you are exempt from paying capital gains.
SPURRING INVESTMENT AND
CONNECTING WITH COMMUNITIES
Opportunity Zones have the potential to spur investment and development in Houston. Furthermore, investing in Opportunity Funds connects investors to communities with real needs. In addition to the benefits to the people of Houston, Opportunity Zone investments offer tax benefits to investors.
For additional information on investment opportunities in Houston and in Texas, contact Lumicre Group today.
QUALIFIED OPPORTUNITY EXAMPLE ECONOMICS AND
COMPARISON TO OTHER INVESTMENTS
The following presents an investor’s after-tax funds available under different scenarios, assuming various holding periods, annual investment appreciation of 7%, and a long term capital gains rate of 23.8% (federal capital gains tax of 20% and the net investment income tax of 3.8%):
Investing in an QO Fund vs. Standard Stock Portfolio with a capital gain of $100 reinvested in 2018
INVESTMENT IN A STOCK PORTFOLIO / INVESTMENT IN A QO FUND
HOLDING PERIOD | APPRECIATION RATE | TOTAL TAX LIABILITY $ | AFTER TAX FUNDS $ | TOTAL TAX LIABILITY $ | AFTER TAX FUNDS $ | DIFFERENCE IN AFTER TAX ANNUAL RATE OF RETURN |
5 year | 7% | 31 | 100 | 31 | 109 | 1.9% |
7 year | 7% | 35 | 111 | 35 | 126 | 1.8% |
10 year | 7% | 51 | 132 | 20 | 176 | 1.9% |
EXAMPLE 1
Taxpayer purchased Amazon stock in 2016 for $50 which is worth $150 in 2018. Taxpayer sells the stock and receives $150 in cash of which $50 is returned to the taxpayer and $100 is invested in a QO fund. The investor holds the investment in the 00 Fund for 10 years.
The taxpayer can defer the taxes owed on the $100 of gain until 2026. Further, because the investor will hold the asset for at least 7 years, a basis step-up of $15 would be applied and this the tax due will be $20 ($85 times 23.8%) in 2026. Since the investment was held for 10 years, there will be no further tax due on the appreciation of the original $100 investment.
Total Tax: $20
After-Tax proceeds: $176
Effective Tax Rate on original and QO Fund investment 10.2% ($20 divided by $196 of ending value)
Effective after-tax annual return: 5.8% (7% assumed annual return less tax leakage)
EXAMPLE 2
Assume the same facts as in example 1, but the investor only holds the 00 fund investment for 7 years. As in example 1, the investor can temporarily defer the tax owed on the original stock sale and will receive the same 15% step-up in basis.
Thus, the investor will owe the same $20 in tax in the year of sale ($85 times 23.8%) based on the original capital gain; however, unlike example 1 because the investment in the QO Fund was not held for 10 years there will be no exemption from the appreciation on the investment.
If we assume that the investment grows 7% annually, then the taxpayer will owe an additional $15 ($61 of gain times 23.8%) of tax upon exit.
Total Tax: $35
After-Tax proceeds: $126
Effective Tax Rate on original and QO Fund investment 21.7% ($35 divided by $161 of ending value)
Effective after-tax annual return: 3.3% (7% assumed annual return less tax leakage)
EXAMPLE 3
Assume the same facts as in example 1, but the investor only holds the 00 fund investment for 5 years.
As in example 1, the investor can temporarily defer the tax owed on the original stock sale but will receive only a 10% step-up in basis. Thus, the investor will owe $21 in tax in the year of sale ($90 times 23.8%) based on the original capital gain.
However, unlike example 1 because the investment in the 00 Fund was not held for 10 years there will be no exemption from the appreciation on the investment.
If we assume that the investment grows 7% annually, then the taxpayer will owe an additional $10 ($40 of gain times 23.8%) of tax upon exit.
Total Tax: $31
After-Tax proceeds: $109
Effective Tax Rate on original and QO Fund investment: 22.1% ($31 divided by $140 of ending value)
Effective after-tax annual return:1.8% (7% assumed annual return less tax leakage)
What Makes an Opportunity Zone?
Governors of states and territories and the mayor of Washington D.C., nominated potential census tracts within their jurisdictions as Opportunity Zones. In areas with less than 100 census tracts, 25 census tracts were eligible.
To date, there are over 8,700 Qualified Opportunity Zones in every U.S. state and D.C. What’s more, there are O-Zones in five U.S. territories – the Virgin Islands, American Samoa, Guam, Northern Mariana Islands, and Puerto Rico (the entire island is a designated Opportunity Zone).
Opportunity Zone Criteria
As stated above, becoming an Opportunity Zone requires nominations. However, to receive an Opportunity Zone designation, a tract it has to be economically distressed. In addition, tracts need to meet several low-income requirements criteria (outlined by IRS Code Section 45D(e)):
- Minimum 20% poverty rate OR
- Median family income of:
- Less than 80% of statewide median family income for non-metropolitan census tracts
- Less than 80% of greater statewide median family income OR the overall metropolitan median family income
Overall, 25% of census tracts in a given jurisdiction were eligible for nomination. What’s more, another 5% were eligible, providing they met both of the following criteria:
- Census tracts directly adjacent to a low-income O-Zone
- Median family income less than 125% of the median family income (relative to the adjacent QOZ)
Based on these criteria, almost 60% of American neighborhoods were eligible for nomination. Yet only 12% of all census tracts received the designation.
F.A.Q.
If done correctly, it may be possible to defer capital gains taxes for 7 years. Subchapter Z provides incentives for investments in qualified opportunity zones (QO Zones) by means of temporary capital gain deferrals and ultimately permanent exclusion from gross income of capital gains, if certain requirements are met.
Governors of each state proposed census tracts. You can use our searchable map to see if a specific address is inside of an Opportunity Zone.
There are 150 opportunity zones throughout the greater Houston, Texas area.
Qualified opportunity zone funds can invest in office buildings, RV parks, retail center, multifamily apartments and even the stock of business located inside of an Opportunity Zone.
An eligible partnership or corporation must self-certify by completing Form 8996 (Qualified Opportunity Fund) with its federal tax return. This return must be filed in a timely manner, taking into account any extensions. For more details, consult the Form 8996 instructions.
No. You don’t need to live, work, or operate a business within the Opportunity Zone.
Consult the IRS list of designated Qualified Opportunity Zones – IRS Notices 2018-48 (PDF) and in 2019-42 (PDF). Also, Opportunity Zones Resources has a map of Qualified Opportunity Zones.
Click here for a full listing of all Texas Opportunity Zones.
The 11-digit census tract numbers (GEOIDs) can be found using the U.S. Census Bureau’s Geocoder.
Yes, but you must file an amended return. Use Form 1040-X and attach Form 8949.
Still have questions? Visit the IRS Opportunity Zones Frequently Asked Questions page to learn more.