Defer Capital Gains:
Capital gains, including those under Code Section 1231, can be strategically invested into a Qualified Opportunity Fund (QOF) within 180 days of selling the asset, or even longer under specific conditions. This investment defers the capital gains tax, leaving it untouched by the IRS until the investor sells or exchanges the QOF interest or until December 31, 2026, whichever comes first. The key to this strategy is that the sale must not occur within ten years of the investment in the applicable QOF. As far as the movement of your capital gain funds – you’ve got a window of 180 days to channel the gain into your QOF. This countdown starts from when the gain would normally be recognized for tax purposes, unless you opt to defer it. If the gain is tied to an entity that issues a K-1, you have three paths to calculate this 180-day period, but you can only walk down one. Here’s how it breaks down:
- From the Gain’s Occurrence Date: Mark the date the gain happens, and from there, you have 180 days to direct the gain into the QOF. That’s your deadline.
- From the Entity’s Tax Calendar Year End: Alternatively, you can kick off the 180-day countdown from the close of the entity’s tax calendar year. The finish line? The investment deadline.
- From the Entity’s K-1 Due Date: There’s a third option, too. Start the 180-day timer from when the entity’s K-1 is due. This path also leads to the investment deadline.
Consider Forming a Captive QOF
A Captive QOF is one that is formed, funded, and managed by the investor. The fund structure can be customized according to your investment criteria, providing flexibility in choosing Opportunity Zone real estate or multiple Qualified Opportunity Zone Businesses (QOZBs). Advantage of a Captive QOF is the ability to reinvest cashflow and refinancing proceeds into additional Qualified Opportunity Zone properties. This means a Captive QOF can invest in Opportunity Zone real estate properties directly and/or into multiple Qualified Opportunity Zone Business (QOZB) from third-party funds managed by general partners.
This strategy maximizes your tax benefits by keeping the money within the QOF rather than having it sent back personally, hence remaining tax-advantaged. If you invest through Captive QOF into a general partner’s QOZB then the money will be sent back to your QOF and remain tax advantaged.
Why is there a focus on growing the captive QOF? If you hold the QOF for 10 or more years then you get to step up the tax basis of the property assets to fair market value. Even the new properties acquired in year 2-9.Using refinance, sale, and cashflow proceeds to get your QOF invested in more QOZB deals is amplifying the tax benefits.
Basis Step-up in Year 10: Tax Benefit
After holding a QOZB for at least 10 years in the QOF or Captive QOF, you can step up your tax basis to the fair market value of the property. This basis Increase is a significant benefit as it reduces potential capital gains when you decide to sell.
For example: you purchase a OZ qualifying heavy value-add real estate property for $3,000,000 in year 1 of your capital gains deferment, you get to depreciate it for 10 years (minimum). In this example for simplicity purposes, assuming there’s no allocation to land, it’s a $109,090 ($3,000,000/27.5 years) of tax depreciation deduction every year.
Continuing with our example, if you were to sell the property on year 10 for $5,000,000, your cost basis will also be $5,000,000, meaning you will have no taxable gain or loss on the sale. This is in addition to all of the tax depreciation deduction that you were taking for 10 years. Meaning that you will not be subject to depreciation recapture if you sell the property past year on year 10. This leads to potential tax strategies.
Cost Segregation study on OZ Real Estate property: Tax Benefit
Using a cost segregation study to separately allocate property by types of the real property into – 5-year, 7-year, 15-year and electing to take bonus depreciation (80% in tax year 2023) on those property, you are potentially claiming a 25% (estimate) write-off (tax depreciation) of the whole property purchase on year 1.
So going back to our example, a $3,000,000 building purchase, you will receive a depreciation deduction due to bonus depreciation of likely 25% of purchase cost. if you or your spouse qualify to the real estate professional status (REPS) designation, you can potentially offset accelerated losses generated from bonus depreciation with other sources of ordinary income (like W-2 or other business income)
Arizona Eligible Opportunity Zone Tracts
You can find real estate OZ eligible tracts & map HERE.
Real Estate Tax Complexities:
Navigating the world of real estate investing in Opportunity Zones is daunting. Be very careful in all the tax filings, failing to satisfy requirements at any point could result in penalties ranging from a nominal interest charge at the low end to a complete loss of the exclusion from tax on the capital gain. It is important to find a specialized real estate CPA, someone who truly understands the requirements, and the filings required.
Consider working with us:
At JG CPA & Advisory, P.A., we have unique expertise on Opportunity Zone tax compliance/structures and the real estate industry, our specialization normally uncovers opportunities that often elude other CPA practitioners. We are NOW ACCEPTING new clients for the 2023 tax year, offering solutions in tax strategizing & planning, accounting, financial services, and tax preparation. Our goal is not merely to minimize your effective tax rate for this year, but to craft intelligent strategies for the years ahead. Partner with us and leverage our robust experience to maximize your after-tax income.
To work with us:
Step 1: Fill out the webform below – the more information you provide the better.
Step 2: After submission of the webform, you’ll receive an email from us with next steps.
Step 3: Based on the information provided, we’ll then hold an initial consultation.
Complete the Webform Here.