This is the second post in a series of articles wherein we will dive into the new “Opportunity Fund” program. In our first post, we described the general framework for the new Opportunity Fund program which you can find here.
There are three tax benefits that investors in an Opportunity Fund can take advantage of, (i) deferral of gain from the sale of property, (ii) partial forgiveness of this gain, and most importantly, (iii) tax-free appreciation in the investment in an Opportunity Fund.
Gain Deferral
The first thing a taxpayer must do to take advantage of the first tax benefit is to invest the gain from the sale of property into an Opportunity Fund within 180 days of the sale.
By making the proper election and doing this, the taxpayer can defer the tax on the gain that would have been due. The deferral lasts until December 31, 2026 or until the sale of the investment in the Opportunity Fund that the gain was invested into, whichever comes first. There are three very important takeaways:
- Only the gain must be invested into an Opportunity Fund, and not the entire amount of proceeds.
- It is currently unclear whether the gain can be any gain or must be a capital gain.
- The deferral will not last beyond 2026. You also cannot manufacture gains, as there are rules that prevent you from selling gain property to a related party to create gain, and constructively keep the property.
Partial Forgiveness of the Tax on Initial Gain
The second incentive is that taxpayers can receive an increase in basis of their investment in the Opportunity Fund if kept in the Opportunity Fund for a certain period of time. If the investment is kept in the Opportunity Fund for at least 5 years, the taxpayer gets a 10% step up in their basis, and, if kept in the Opportunity Fund for 7 years, a 15% basis step-up is received. Essentially, tax savings of 10% or 15% can be achieved depending on how long the investment is held in the Opportunity Fund. It is important to note that due to the December 31, 2026 gain deferral deadline, taxpayers must invest in an Opportunity Fund by December 31, 2019 to get the 15% benefit and by December 31, 2021 to receive the 10% benefit.
Tax-Free Appreciation
The last, but certainly not least, incentive is tax-free appreciation of the investment in the Opportunity Fund. This is, in fact, the most compelling benefit of the program. To take advantage of this benefit, an election must be made upon the initial investment in an Opportunity Fund to lock up the rollover of gain for at least 10 years. If the election is made, and the investment is held in the Opportunity Fund for 10 years, all gain in the Opportunity Fund investment when sold, will be tax-free gain! Essentially, the taxpayer will receive a basis step-up to the fair market value of the sale price of the Opportunity Fund investment when sold. Here’s an example: “If 1 Million Dollars of gain is rolled over into an Opportunity Fund, and after 10 years, the taxpayer sells the investment for Ten Million Dollars, then the taxpayer will get Nine Million Dollars of gain tax-free”. This taxpayer can save $1.8 Million in addition to the benefits discussed above.
Keep watching for the next article in the series where I will discuss how the Opportunity Funds work and what you can invest in.
Vikram Agarwal is a shareholder with Bean Kinney & Korman with an expertise in tax law. Please contact Vikram if you would like to learn more about the Opportunity Fund program at vagarwal@beankinney.com.
Any tax advice expressed above by Bean Kinney & Korman, PC was not intended or written to be used, and cannot be used, by any taxpayer to avoid U.S. federal tax penalties. If such advice was written or used to support the promotion or marketing of the matter addressed above, then each offeree should seek advice from an independent tax advisor.
This Bean Kinney & Korman publication provides information and comments on legal issues and developments. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek legal advice before taking any action with respect to the matters discussed herein.