- The Tax Cuts and Jobs Act created qualified opportunity funds: investments that direct money to low-income or distressed areas and offer investors a tax break in return.
- You can invest capital gains into a qualified opportunity fund and defer taxes on those gains if you hold the fund for at least five years.
- To get the biggest break — a 15% exclusion of your original capital gain — you must invest in one of these funds by Dec. 31, 2019.
Time is nearly up for the largest tax break on this hot new investment.
So-called qualified opportunity funds were created by the Tax Cuts and Jobs Act of 2017.
These funds offer taxpayers a chance to invest in economically distressed communities and snag an attractive tax break for doing so — provided they stay in the fund for at least five years.
The offerings are so new that the IRS and the Treasury Dept. have been struggling to hammer out new guidance on this provision.
On Dec. 19, the federal agencies issued a round of final regulations detailing the types of real estate properties that are eligible, as well as the circumstances in which investors can capture a tax benefit.
To top it all off, investors who want the maximum tax break have only until Dec. 31 to make the approved investments.
"If you're not well on the way to that already, you won't get it done," said Edward Renn, partner on the private client and tax team for law firm Withers. "Wait until next year and find something that will do well."
Those who put their capital gains into a qualified opportunity fund in 2020 may be eligible for a 10% exclusion of those gains if they hold onto the fund for at least five years.
Money invested prior to the new year is eligible for a 15% exclusion if invested for at least seven years.
Investors have put close to $4.5 billion into qualified opportunity funds as of Dec. 10, according to Novogradac, an accounting consultancy that specializes in real estate. The firm surveyed 184 funds.
Cities seeing the most investment are Los Angeles, New York, St. Louis, Indianapolis and Nashville, Tennessee, said Michael Novogradac, CPA and managing partner at the eponymous firm.
Here's what you should know before you jump in.
To make this worth your while, you must generate significant capital gains — perhaps by selling a business. Cash you invest from other sources is considered "non-qualified" and is ineligible for the tax break, said Renn.
You have 180 days from the sale of your property to roll your gains into a qualified fund, which invests in property that's located in an opportunity zone.
You can defer taxes on the capital gains that you invest in the fund either until you sell your holding or Dec. 31, 2026, whichever is earlier.
The longer you hold the fund, the sweeter the tax break.
If you remain in the fund for more than five years, you can exclude 10% of your originally deferred gains.
Stick around for more than seven years — that is, make your investment by Dec. 31, 2019 — and the exclusion goes up to 15%.
If you wind up waiting until 2020 to invest, you'd be eligible for the 10% exclusion on your invested gains.
In addition, those who own the fund for at least 10 years won't owe taxes on any appreciation once they sell their holding.
Qualified opportunity funds aren't for the uninitiated.
For starters, since these investments involve real estate, there's an element of complexity and illiquidity.
"There are smaller investors who do this, as well," said Richard LaFalce, a partner at Morgan Lewis. "They might have their own capital and identify a piece of real estate that they want to acquire and are becoming not just the investor but the operator."
Investors in these funds also face layers of expenses, including selling commissions, managing dealer fees and other costs.
"There are complicated offering statements," said Renn. "What you're going to look at is a significant tranche of fees – some are reasonable, and some aren't."
Well-to-do investors could, in theory, create their own qualified opportunity fund, he said.
Accredited investors must have a net worth of at least $1 million, excluding their residence, and income exceeding $200,000 in each of the last two years. This threshold goes up to $300,000 for a married couple.
No investor should go into this without consulting an accountant or a financial advisor. That's because ownership in a fund can come with unexpected tax-planning consequences.
For instance, if you split from your spouse and you transfer your interest in the fund to your ex, per the divorce decree, you now must recognize the deferred gain on your taxes, according to the final regulations published earlier this month.
Further, if you gift your interest in a qualified opportunity fund to your child while you're still deferring your capital gains, you must include that deferred gain on your tax return.
"That's a nightmare and another thing to worry about," said Dan Herron, CPA and principal of Elemental Wealth Advisors in San Luis Obispo, California. "The inclusion events are the hardest terrain to navigate with this sort of thing."