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This year begins the start of an interesting new program that can allow you to diversify your portfolio without making the same types of investments. Aptly named, opportunity zones. Make sure you're a good fit for them.
Act by December 31 to get full tax benefits on a new program that could diversify your investing portfolio. Opportunity Zones.
Taxpayers have a unique opportunity in 2019, thanks to the new Opportunity Zones program. It offers valuable tax breaks to investors who reinvest capital gains in projects designed to bolster economically struggling communities. You can reduce your taxes, potentially make a long-term profit and help the targeted areas.
Under the 2017 tax law, Opportunity Zones are census tracts certified as experiencing economic distress. The idea is to spur investments and job creation in these areas.
To invest, you need a recent capital gain or gains—whether it’s from selling a business, property, stock or mutual fund. Short and long-term gains are eligible.
You then can reinvest your capital gain(s) in a Qualified Opportunity Fund that holds at least 90 percent of its assets in Opportunity Zone property—stock, partnership interests or business property, including real estate. You must invest the gain(s) in a fund within 180 days of receiving the gain.
The minimum investment for many funds is $100,000, though some funds have higher minimums. While most people don’t have such large unrealized gains, they’re not entirely unusual. If you have too much invested in a stock that has appreciated a lot, or have an appreciated home you want to sell, this program offers a way to diversify without taking a tax hit.
These are the three distinct tax benefits.
You get the immediate benefit of not having to report the capital gain on your tax return in the year you received it.
Initially, your basis in the Qualified Opportunity Fund is $0, in exchange for the capital gain tax deferral. After 5 years, your basis increases to 10 percent of the gain that you initially elected to defer. After 7 years, the basis gets another 5 percent bump, for a total basis of 15 percent of the initial capital gain. For example, if you invest $100,000 in capital gains, after seven years your basis will be $15,000.
Investors who want the greatest possible tax benefit need to invest in a Qualified Opportunity Fund by December 31, 2019. This is because investors are allowed to defer tax on the original gain until the earlier of December 31, 2026 or the date the investor sells or exchanges the position in the fund.
All investors must report deferred capital gains by the end of 2026 on their tax return, regardless of how long they have held the property. Thus, to get the full 15 percent basis adjustment, you must act this year.
The program includes a test at six months. So, by December 31, 2019, to make sure that all assets in a Qualified Opportunity Fund meet the “90/10” rule, at least 90 percent of a fund’s assets must be qualified Opportunity Zone property. If a fund fails this test, the government will impose financial penalties and the fund will pass through to investors. Making it crucial to choose a competent fund manager.
Look before you leap. Consult a tax and investment professional—an individual or firm that can vet both the tax consequences and the fund manager. Consider the pros and cons of other ways to blunt the tax hit, such as selling the security over multiple years and taking offsetting losses.
Regulators are doing all they can to give potential participants the green light even before regulations are fully final. With a bit of caution and common sense, investors with appreciated securities or property can make the most of the opportunity Congress created.
Melinda Kibler, Certified Financial Planner (CFP®), Enrolled Agent (EA), is a client service and portfolio manager with Palisades Hudson Financial Group’s Fort Lauderdale, Florida, office. She contributed several chapters to the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including “Estate Planning, “Financing Long-Term Care” and “Retiring Abroad.”
Palisades Hudson is a fee-only financial planning firm and investment manager based in Fort Lauderdale, Florida with $1.4 billion under management. It offers financial planning, wealth management, and tax services. Its Entertainment and Sports team serves entertainers and professional athletes. Branch offices are in Stamford, Connecticut; Atlanta, Georgia; Portland, Oregon; and Austin, Texas. The firm’s daily blog and monthly newsletter covering financial planning, taxes and investing are online at www.palisadeshudson.com.