The Tax Cuts and Jobs Act of 2017 significantly altered the U.S. Tax Code through changes to capital gains treatments, personal deductions, and a series of other revisions. For real estate investors and businesses, the creation of opportunity zones offers significant tax reductions. The purpose of the opportunity zone program is to incentivize investors to redeploy capital to lower-income areas. The program does so by deferring and limiting capital gains for the disposition of assets and reinvestment of those funds in opportunity zones.
How do opportunity zones work?
Opportunity zones are census tracts designated by individual states for preferential federal tax treatment. States cannot designate more than 25% of low-income census tracts to receive opportunity aone status. Once an opportunity zone has been identified, an opportunity fund (e.g., a special purpose vehicle) must be established by investors to invest more than 90% of the fund’s assets in qualified investments within the opportunity zone. Investments can include commercial and industrial real estate, housing developments, infrastructure, and businesses (existing or new start-ups). To be a qualified real estate project within an opportunity zone, and thus receive preferential tax treatment, the investment must “substantially improve” the property.
What are the tax benefits?
Redeploying capital in opportunity zones presents three tax benefits for investors:
- Temporary deferral of taxes on prior capital gains. If assets have accumulated capital gains, the investor may use those assets to invest in an opportunity fund, which results in the accumulated capital gains being deferred until 2026.
- A step-up in the basis of capital gains reinvested. If assets with accumulated capital gains are invested via an opportunity fund for at least 5 years, the basis of the original investment is increased by 10%. At 7 years, the basis of the original investment is increased by 15%.
- Permanent exclusion of capital gains. If an investor stays invested in an opportunity fund for at least 10 years, any capital gains accumulated in that period of time are excluded from taxation.
Thus, opportunity zones present a possibility for investors to increase their basis on existing assets, resulting in lower overall capital gains at the later deferred date, and to exclude capital gains on new long-term investments. Additionally, investors realizing capital gains outside of an opportunity fund have 180 days to reinvest those capital gains in an opportunity fund to be eligible to receive the above-stated tax benefits.
In Rhode Island, 25 census tracts spread across 15 municipalities, including Bristol, Newport, North Providence, and Pawtucket, have been identified as opportunity zones. At the Law Offices of Richard Palumbo, our attorneys and staff have successfully helped investors and business owners in structuring their real estate investments and businesses to minimize taxes while maximizing returns and safety. If you are interested in learning more about opportunity zones in Rhode Island or are considering investing or reinvesting capital, please contact our office to set up a consultation or complete the contact form.
