Capital gains taxes often catch taxpayers off guard when it comes time to pay. Many don’t realize there may be a way to reduce, defer, or eliminate these costly taxes. Reinvesting in opportunity zones is one of the best tax benefits for those facing a hefty capital gains bill.
The maximum capital gains tax can reach a staggering 20 percent on a single asset, but reinvesting capital gains into opportunity zone can reduce this burden. In many cases, doing so will reduce the tax by 10 percent, and after holding for a decade, the IRS considers it a completely tax-free investment.
What Is an Opportunity Zone?
According to the IRS, a qualified opportunity zone (QOZ) is a low-income neighborhood that needs to be revitalized. To qualify, the community must have a poverty rate of at least 20 percent. The government offers huge tax incentives for anyone willing to invest in QOZs. Individuals, LLCs, corporations, trusts, and estates can all invest in these designated areas.
The goal of opportunity zones is to increase economic development in lower-income neighborhoods. Rewarding investors with tax deferments makes these seemingly risky communities more alluring. As people reinvest their capital gains into QOZs, it increases cash flow, promotes new business, and helps bring poorer regions out of poverty.
Top Benefits of Reinvesting in QOZs
Why would someone want to reinvest their capital gains into a rundown community? It will help them reduce their tax burden in the long run. These investments offer a temporary tax deferral on previously earned capital gains. Investors can even bundle existing assets with the original capital gain in a qualified opportunity zone fund. Once they do, they will not be taxed on the existing capital gains until December 31, 2026, or until they dispose of the asset.
The longer the investment length, the more tax benefits the holder enjoys. After five to seven years, the investor will get the standard tax deferment and a 10 percent reduction in the original capital gains tax. When the investment surpasses seven to ten years, the government applies a five percent reduction to the capital gains. After a decade, the QOZ matures fully, and the investor receives a permanent tax exclusion.
Rules Investors Must Follow
Opportunity zones were first created in The 2017 Tax Cuts And Jobs Act. The goal was to lower the tax burden on the middle class and reward wealthy individuals for investing in poverty-stricken neighborhoods. Qualified opportunity zones were initially seen as a way to build more affordable housing and bring new jobs to these in-need communities.
Any housing improvements must be substantial for the current residents to ensure the investment benefits the neighborhood. For example, building high-quality, affordable homes or apartments is welcome. On the other hand, opening businesses that don’t fit well, like casinos or luxury condominiums, is frowned upon. Although many people enjoy these high-class real estate properties, they won’t do much to help the community’s residents in the short term.
Contrary to popular belief, investors do not need to live, work, or own a business in a QOZ to qualify for tax benefits. As long as they invest the required amount, they can elect to take the tax deferment on their capital gain.
Reduce Taxes and Help Communities
Wealthy investors are always looking for more ways to reduce their tax burdens. It’s possible to defer capital gains by investing in a QOZ. Not only will doing so help the investor keep more money in their pocket, but it will also help revitalize a struggling community. Opportunity zones may prove to be just what the country needs to help break the cycle of poverty.