Defer Capital Gains by Investing in Qualified Opportunity Funds | BNY Mellon Wealth Management (2024)

FAQs

Can you invest in an opportunity fund without capital gains? ›

One question that sometimes pops up is: “Can I invest non-capital gains into an opportunity zone?” The answer is no, for two reasons: Only capital gains can be invested in this program. Investors don't put monies directly into Opportunity Zones.

When you dispose of a property and generate a capital gain, you can defer tax by reinvesting in a like-kind real estate investment property. However, these capital gains taxes are only deferred and need to be paid in the future when they're realized.

By investing in an Opportunity Zone through such a fund, investors can temporarily defer capital gains taxes. Once they sell an asset for a gain, they have 180 days to invest the money into a Qualified Opportunity Fund. 4 If they do, they can defer capital gains taxes through 2021 or longer.

Although the contribution deadline for the step-up in basis provisions have passed, the Qualified Opportunity Zone still provides taxpayers the ability to defer the capital gains. A taxpayer may defer the gain until 2026 or a year prior to that if the investment is sold.

Capital Gains Deferral Strategies

Using a 1031 exchange allows you to defer any capital gains tax liability indefinitely through continuous reinvestment of capital, and capital gains taxes are not due until you sell the swapped asset. With this strategy, you may only pay one tax at a long-term capital gains rate.

Temporary tax deferral: You can temporarily defer capital gains and gains on the sale of business property. Gains must be reinvested within 180 days of the day they are recognized as taxable income.

It allows investors to defer 100% of their capital gains taxes as long as they reinvest their sales proceeds into a “like kind property (the replacement property),” which is why this transaction is sometimes referred to as a “like kind exchange”.

Generally, you have 180 days to invest an eligible gain in a QOF. The first day of the 180-day period is the date the gain would be recognized for federal income tax purposes if you did not elect to defer the recognition of the gain.

The Qualified Opportunity Zone program offers taxpayers a potential federal capital gains tax incentive for investing in economically distressed areas of the US. The potential tax benefits include deferral, discount, and exemption from federal capital gains taxes.

Where should I invest to save capital gains tax? ›

Qualified Opportunity Zones are challenged areas designated for incentivized economic development. They are identified by the states and certified by the IRS. Individuals may defer short- or long-term capital gains from the sale of existing assets if they reinvest their gain in a QOF within 180 days of the sale.

Up to 15% of the deferred gain is permanently excluded from income if the opportunity zone investment is held for more than seven years (Secs. 1400Z-2(b)(2)(B)(iii) and (iv)). In other words, the investor will pay tax on only 85% of the deferred gain when that gain is eventually recognized.

Section 2302 of the CARES Act allowed self-employed individuals and household employers to defer the payment of certain Social Security taxes on their Form 1040 for tax year 2020 over the next two years. Half of the deferred Social Security tax is due by December 31, 2021, and the remainder is due by December 31, 2022.

If you hold your investment in the Qualified Opportunity Fund for at least 10 years, you may be able to permanently exclude gain resulting from a qualifying investment when it is sold or exchanged.

Use Form 8997 to inform the IRS of the QOF investments and deferred gains held at the beginning and end of the current tax year, as well as any capital gains deferred by investing in a QOF and QOF investments disposed of during the current tax year.

A qualified opportunity zone fund can be established by any taxpayer by filing Form 8996 (opens in new tab) and submitting it with their federal income tax return. The purpose of this form is to certify individuals, partnerships or corporations as organizations for investing in qualified opportunity zones.

2 For example, if a property is purchased for $700,000, then the opportunity fund has a 30-month window to make at least $700,000 worth of improvements. Certain types of businesses cannot be included in opportunity funds, even if they reside within opportunity zones.

What is the CGT Six-Year Rule? The capital gains tax property six-year rule allows you to use your property investment, as if it was your principal place of residence, for a period of up to six years, whilst you rent it out.

If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse.

Should I automatically reinvest capital gains? ›

The eventual decision you take when thinking should I reinvest capital gains will depend on the individual. If the investment has been made for long-term purpose, then it is probably best to re-invest it. However, if you are looking for immediate gains, you should take the exit and enjoy the proceeds in your pocket.

In recent times, the process allows you to trade real estate property used for sale or investment into other real estate property, thereby deferring capital gains taxes on the sale of those assets. For how long? For as long as you want, though a typical property hold period is seven to eight years.

Miss the 45-Day Identification Deadline

Once you close on your relinquished property, you have 45 days to identify in writing what you intend to acquire in the exchange. The only exception to this rule is that no identification is needed if you acquire the replacement property before the end of the 45-day period.

Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031.

The wash-sale rule states that, if an investment is sold at a loss and then repurchased within 30 days, the initial loss cannot be claimed for tax purposes. So, just wait for 30 days after the sale date before repurchasing the same or similar investment.

You can use income spreading when you sell a capital asset and the terms of the sale dictate that the buyer will make installment payments out over more than one tax year. This type of arrangement may allow the seller to report the capital gains from the sale over multiple years.

Carrying gains and losses forward

When a net capital loss exceeds the $3,000 limit, it can be carried forward to future years. In the following year, the loss carried forward would first be used to offset potential capital gains.

December 31, 2028 — Expiration of the designation of Qualified Opportunity Zones. QOZFs may still be active after this date to receive the 10-year exclusion.

Because of this, an investor cannot combine a 1031 with a QOZ investment. A QOF is not “like kind” to real estate and would not qualify as replacement property. Similarly, because the QOF is invested in the property rather than the individual, the individual investor cannot 1031 exchange out of a QOZ investment.

A: The tax incentive itself does not expire in 2026. Investors in Opportunity Funds that hold investments for at least 10 years will still be able to take advantage of the favorable tax treatment of gains related to the investments into Opportunity Funds, even if realized after 2026.

What are the benefits of investing in a qualified opportunity zone? ›

Opportunity Zones are an economic development tool that allows people to invest in distressed areas in the United States. Their purpose is to spur economic growth and job creation in low-income communities while providing tax benefits to investors.

The new law will allow Qualified Opportunity Zone (QOZ) investors to reduce their capital gains taxes by up to 15% if they re-invest their realized gains in a Qualified Opportunity Fund (QOF) by December 31, 2022, and by 10% if they re-invest by year end 2023.

Qualified Opportunity Zone (QOZ) investments are among the highest risk opportunities available for real estate investment. It is essentially ground-up development in unproven locations.

Investors who take their capital gains and reinvest them into real estate or businesses located in an opportunity zone can defer or reduce the taxes on these reinvested capital gains.

QOZ fund investors receive a full deferral on both long-term and short-term capital gains. Plus, you don't have to net gains against losses on your individual tax return.

Individuals reinvest the proceeds into specified assets before the end of 6 months from the day the asset was sold. Capital gains should not be more than the investment amount. If only a portion of gains were reinvested, an exemption under capital gain would be applicable only on the amount that was reinvested.

One question that sometimes pops up is: “Can I invest non-capital gains into an opportunity zone?” The answer is no, for two reasons: Only capital gains can be invested in this program. Investors don't put monies directly into Opportunity Zones.

A deferred tax liability represents an obligation to pay taxes in the future. The obligation originates when a company or individual delays an event that would cause it to also recognize tax expenses in the current period.

Saving for retirement by investing in a tax-deferred vehicle can give you a big boost over time—forgoing the tax bite while you grow your money and potentially lowering the tax impact when take income. Tax-deferral is a feature of many investment vehicles (variable annuities, IRAs, 401(k) plans).

Do you have to pay back the tax deferral? ›

One-half of the deferred taxes must be paid no later than December 31, 2021, with the remaining balance due by December 31, 2022.

To defer tax on an eligible gain, you must invest in a Qualified Opportunity Fund in exchange for equity interest (not debt interest) within 180 days of realizing the gain. In general, if you don't defer the gain, the gain would be recognized for federal income tax purposes the first day of the 180-day period.

Many times, we hear the question: “What ordinary income gain cannot be invested in an Opportunity Zone?” The answer is pretty clear-cut: All of it. In other words, the Qualified Opportunity Zone (QOZ) program is specifically geared for capital gain investment, not the investment of ordinary income.

Opportunity Zones were created under the Tax Cuts and Jobs Act of 2017 (Public Law No. 115-97). Thousands of low-income communities in all 50 states, the District of Columbia and five U.S. territories are designated as Qualified Opportunity Zones. Taxpayers can invest in these zones through Qualified Opportunity Funds.

First, you need to report those capital gains. And second, you need to report that those gains are being invested in a QOF. As such, the two IRS forms you must fill out when it comes to your Opportunity Zone investments are 8949 and 8997.

180-Day Investment Period

Generally, you have 180 days to invest an eligible gain in a QOF. The first day of the 180-day period is the date the gain would be recognized for federal income tax purposes if you did not elect to defer the recognition of the gain.

Net investment income generally does not include wages, unemployment compensation, Social Security Benefits, alimony, and most self-employment income. Additionally, net investment income does not include any gain on the sale of a personal residence that is excluded from gross income for regular income tax purposes.

The Qualified Opportunity Zone program offers taxpayers a potential federal capital gains tax incentive for investing in economically distressed areas of the US. The potential tax benefits include deferral, discount, and exemption from federal capital gains taxes.

Qualified opportunity zone tax benefits only apply to capital gains, not to ordinary income. If a transaction produces both ordinary income and capital gains, the entire gain can still be invested in a QOZ if the taxpayer elects to do so, but only the capital gain amount will be eligible for the QOZ benefits.

you will also suffer opportunity cost. You may lose the chance to defer your gain and receive the long-term tax benefits you were seeking, if the fund you've selected does not qualify the investment in time and has to return capital to investors.

Can anyone invest in a qualified opportunity fund? ›

A qualified opportunity zone fund can be established by any taxpayer by filing Form 8996 (opens in new tab) and submitting it with their federal income tax return. The purpose of this form is to certify individuals, partnerships or corporations as organizations for investing in qualified opportunity zones.

Because of this, an investor cannot combine a 1031 with a QOZ investment. A QOF is not “like kind” to real estate and would not qualify as replacement property. Similarly, because the QOF is invested in the property rather than the individual, the individual investor cannot 1031 exchange out of a QOZ investment.