The Tax Cuts and Jobs Act1 , passed by Congress in the closing days of 2017, introduced transformative changes to the U.S. economy, including the creation of a new investment model with unprecedented tax incentives for capital gains: Qualified Opportunity Zones and Opportunity Funds.
Opportunity Funds promote investment in the development of low-income communities across the US, by offering investors federal tax advantages that are only available through the new Opportunity Zone program. When investors put their money to work in qualified Opportunity Zones through a qualified Opportunity Fund, they can defer and reduce their capital gains tax burden thanks to provisions outlined by the 2017 law.
In fact, investors can defer and reduce realized capital gains on the principal invested, and even eliminate their capital gains tax burden on returns earned through the sale of investments in qualified Opportunity Zones. While some tax incentives are available to Opportunity Fund investors immediately, in general, the greatest number and extent of tax incentives are available to long-term investors.
An Opportunity Fund is an investment vehicle that intends to invest at least 90% of its holdings into partnership interests, businesses, or property (real estate, factory equipment, etc.) within a qualified Opportunity Zone. Opportunity Funds are required to invest in ways designed to improve the Opportunity Zone’s community, such as supporting a local business or sparking the rehabilitation of local buildings.
In exchange for investing in economically distressed areas, Opportunity Funds offer investors several capital gains tax incentives, which offer ways both to preserve investment dollars now and keep more of the investment return later.
By moving realized capital gains into a qualified Opportunity Fund within 180 days of the asset sale, investors can defer paying capital gains taxes on that gain until December 31, 2026 or until they sell their Opportunity Fund investment – whichever is earlier. Deferring their tax liability allows investors to put a greater amount of capital to work for a longer period of time. Funds that otherwise would have been used to pay taxes upfront can instead be invested and earn returns for several additional years. In other words, the ability to defer capital gains tax gives Opportunity Fund investors a major advantage in the earning power of their dollars.
an investor holds their Opportunity Fund investment for at least 5
years prior to December 31, 2026, they can reduce their
deferred capital gains tax liability by 10% through a step-up in
basis. If that investor holds their Opportunity Fund investment for 2
additional years they can reduce their deferred capital gains liability
by another 5%. That means by holding an Opportunity Fund investment
for 7 years prior to December 31, 2026, an investor can reduce their tax
liability on the deferred capital gains invested in the Opportunity
Fund by 15%.
If an investor holds
their Opportunity Fund investment for another 3 years (10 years total), they
can expect to pay zero dollars in capital gains taxes on