At KROST, we strive to provide opportunities that were previously only available to Fortune 500 companies. One potential tax-saving strategy is through Qualified Opportunity Zone Funds. The Opportunity Zone Program allows investors to revitalize economically distressed communities and receive capital gains tax incentives only available through these funds.
Investors can defer taxes on capital gains, if they reinvest such capital gain into a Qualified Opportunity Zone Fund within 180 days. Capital gain for this purpose includes gain from sale of marketable securities and capital gain generated from a trade or business. There is no limit on the amount of capital gain that can be reinvested into a QOF. The tax is deferred until the the QOF is sold, or December 31, 2026, whichever date comes first.
The Opportunity Zone program was introduced to boost development and encourage long-term investment in low-income areas. Investors of Qualified Opportunity Zone Fund (QOF) get a temporary deferral of capital gain, partial exclusion of gain from income if QOF is held for five years, as well as permanent tax savings on appreciation if a QOF is held for at least ten years.
If the investment in the QOF is held for five years, the investors gets a step up in basis of 10%. This means the investors are only paying tax on 90% of the capital gains that they initially reinvested. For example, if you reinvest $12 million of capital gain in QOF in 2021 and hold the investment until December 31, 2026, $10,800,000 (90% of $2 millions) will be considered income in 2026 tax year.
If you hold the QOF for at least ten years, you can elect to treat your basis in the QOF as its fair market value upon sale, which essentially eliminates the tax on the appreciation of the QOF that increases when you hold the investment. Continuing on the example above, if you reinvest $12 million of capital gain in a QOF in 2021 and sell it for $20 million in 2031 after the 10-year holding period, you can make an election to step up your basis on the QOF to the fair market value, i.e. selling price, upon sale which results in zero taxable gain. The only tax you have paid would be the tax on $10,800,000 gain in 2026. The appreciation of $9,200,000 ($20,000,000 less $10,800,000) is tax-free.