This is the Appendix to The Ultimate Guide to Opportunity Zone Investing
Updated October 29, 2020
Taking advantage of Opportunity Zone investing can save a taxpayer thousands or even millions of dollars on his tax bill, and result in higher ROI. Using our opportunity fund tax calculator, it’s easy to see how powerful the incentive is to invest in Opportunity Zones.
To demonstrate the potential for tax savings and the impact that those savings may have on investment returns, let’s look at a few different hypothetical examples.
(Download this guide as a PDF report… Click here.)
Example #1: $100,000 capital gain invested in a Qualified Opportunity Fund doubles in value after 10-year holding period
In our first example, assume that The Investor realizes a $100,000 capital gain on his original investment. This could be from sale of any asset (stock, mutual fund, real estate, etc.). It doesn’t matter where the gain came from.
On December 31, 2020, The Investor invests the $100,000 capital gain in a Qualified Opportunity Fund. By April 15, 2021, The Investor simply needs to make an election (using IRS Forms 8949 and 8997) on his tax return, showing that this $100,000 capital gain has been rolled over into a Qualified Opportunity Fund. So long as The Investor does not sell or exchange his share in the Qualified Opportunity Fund, his original $100,000 gain is not recognized until December 31, 2026.
In the meantime, his basis in the Opportunity Zone investment steps up by 10 percent on December 31, 2025, effectively reducing the amount of capital gain recognized on the initial investment by 10 percent, per Section 1400Z-2.
Note: A 7-year, 15-percent basis step-up benefit expired after December 31, 2019.
Tax on the original $100,000 gain is deferred until December 31, 2026. Therefore, on April 15, 2027, The Investor finally owes capital gains tax on the original gain. But because he has received a 10 percent step-up in basis on the Opportunity Zone investment, instead of paying capital gains tax on the full $100,000 amount, he is now only obligated to pay capital gains tax on $90,000.
Assuming a long-term capital gains tax rate of 23.8%, The Investor would have a tax bill of $21,420 due on April 15, 2027. Without the Opportunity Zone investment, The Investor would otherwise have owed $23,800 in capital gains tax on April 15, 2019. Effectively, The Investor has received a negative-interest loan from the federal government.
Furthermore, let’s assume that after a 10-year holding period, the investment in the Qualified Opportunity Fund has doubled. The Investor’s $100,000 share in the OZ fund is worth $200,000 when he sells it on December 31, 2030. Having held the opportunity fund for at least 10 years, The Investor is now able to waive his entire gain for tax purposes. He owes 0 on the subsequent $100,000 gain.
Further still, without the ability to defer capital gains, The Investor would have only had after-tax dollars to invest. His $100,000 investment in Opportunity Zones would have instead been just $76,200 (assuming a 23.8% rate taken from the $100,000 gain on the original investment). The Opportunity Zone incentive effectively allows for The Investor to compound additional pre-tax dollars over many years before any liability comes due.
With Opportunity Zones: $100,000 gain from original investment is rolled over into a Qualified Opportunity Fund. Tax on $90,000 is paid in 2027. After 10 years, the Qualified Opportunity Fund investment doubles in value and is disposed of, for an additional gain of $100,000, on which no taxes are due. Total after-tax gain from the two investments comes to $178,580.
Without Opportunity Zones: $100,000 gain from original investment is taxed at a 23.8% rate. After tax, this amounts to $76,200. The $76,200 is reinvested and doubles in value over 10 years for a pre-tax gain of $76,200. After tax, this amounts to $58,064. Total after-tax gain from the two investments comes to $134,264.
In this example, The Investor has a significantly higher after-tax return in the Opportunity Zone investment.
Example #2: $100,000 capital gain invested in a Qualified Opportunity Fund doubles in value after 8-year holding period
In our first example, The Investor took full advantage of the Opportunity Zones tax incentive by holding his Qualified Opportunity Fund investment for a full 10 years. This allowed him to pay no tax on his subsequent $100,000 gain.
In our second example, let’s make all of the same assumptions, except change The Investor’s holding period from 10 years to 8 years. The Investor now sells his share in the opportunity fund on December 31, 2028 for $200,000.
The Investor still receives the 10 percent step-up in basis on the original investment and pays $21,420 in capital gains tax on April 15, 2027. However, since The Investor did not hold his Opportunity Zone investment for the full 10 years, he owes tax on any gain in the fund. In our example, this is a subsequent gain of $100,000. Therefore, The Investor would owe an additional $23,800 in capital gains tax on April 15, 2027, for a total amount owed of $45,220. He was still able to take advantage of several years of compounding pre-tax dollars, but his overall return is much less than in the first example.
Example #3: $100,000 capital gain invested in a Qualified Opportunity Fund loses value
Read about hypothetical Opportunity Zone investments just about anywhere, and they’ll all assume that the Qualified Opportunity Fund will deliver a positive return. But investments do actually lose value sometimes! Let’s assume that in our final example.
The Investor has a gain of $100,000 from his original investment. Within 180 days, he invests this $100,000 in a Qualified Opportunity Fund. He receives the 10 percent step-up in basis on his original investment before his deferred tax on the gains are due on April 15, 2027. He owes $21,420 on this date.
After a 10-year holding period (say, December 31, 2030), The Investor sells his Qualified Opportunity Fund shares for $50,000, thereby realizing a loss of $50,000. He would owe no tax and in fact can use this loss against his income for 2030.
Did you enjoy this free guide?
Learn more about Opportunity Zones by listening to the Opportunity Zones Podcast. Subscribe today.