The qualified opportunity zone program remains one of the most flexible and impactful tax programs passed by Congress in the last 50 years. In this article we distill different forms of capital gains and when they need to be invested to qualify for Opportunity Zone tax incentives:
Individual Gains: Stocks, Real Estate, Gold, Cryptocurrency, and more
Eligible for investment within 180 days of realizing the gain.
Gains from a Partnership or Pass-Through Entity
This applies to partners in a partnership, shareholders of an S corporation, and beneficiaries of estates and non-grantor trusts. Essentially, if you are receiving capital gains noted on a K-1, then this applies to you. These gains have three options to start their 180 day qualifying period:
-The date the entity realizes the gain for tax purposes
-The final day of the entity’s tax year in which the gain was realized (typically December 31)
-The original non-extended date of when the K-1s are due (typically March 15)
For example, let's say that a partnership realizes a capital gain on February 15, 2022, and the partnership’s tax year ends on December 31, 2022, which is most common. In this scenario, the 180 day clock can start on 2/15/2022, 12/31/2022, or 3/15/2023. Most investors with a partnership gain in 2022 will have until September 10, 2023 to place gains in an OZ Fund.
Business and Commercial Real Estate (Section 1231 Gains)
Typically, 1231 gains and losses are netted. However, when investing in an OZ Fund, investors can invest 1231 gains and realize 1231 losses without first netting them, granting investors more potential deductible losses and more available gains to invest.
For example, let's say someone has a $500K 1231 gain and a $200K 1231 loss. They proceed to invest $400K of the gain in an OZ Fund. In this situation, a $100K gain and $200K loss remains after the investment. The gains and losses are netted, leaving a $100K deducible loss. If no investment is made in an OZ Fund, the investor would be left with a $300K taxable capital gain, no deductible losses, and of course no investment in an OZ Fund. All 1231 gains are eligible to invest in an OZ Fund for 180 days after realization.
Unrecaptured Depreciation (Section 1250 Gains)
Yes, unrecaptured depreciation can be invested in OZ Funds. The sale of business and commercial real estate results in two types of gains: the gain on the sale (Section 1231, discussed in the previous paragraph) and the gain on unrecaptured depreciation (Section 1250). To provide a simple example: someone acquires a property for $1M, between buying and selling the property they claim $200K in depreciation, and sell the property for $2M. The 1231 gain for the sale is $1M and the 1250 gain for the sale is $200K. The investor could invest up to $1.2M in an OZ Fund. All 1250 gains are eligible to invest in an OZ Fund for 180 days after realization.
Note on 1031 Exchanges
The transition from 1031 to OZ is extremely simple and maintains significant tax advantages. Investors can sell an existing property, put any portion of their capital gains into an OZ Fund, and extract the principal. Unlike with a 1031, where you need to roll the entire gain and principal forward into like-kind property.
Capital Gains Already Placed in an Existing OZ Fund
A number of investors set up their own Opportunity Zone Fund, but later find more compelling options, such as a professionally managed OZ Fund, or were unable to source the projects required to remain compliant. In this case, if an investor’s gains are still in their original qualified investment window, they can reallocate some or all of their gains out of their OZ Fund and invest them into another OZ Fund. Or if they have exceeded their original qualified investment window, they could co-invest in a project. At Four Points Funding, we typically allow co-investment from other OZ Funds.
Do you still have questions about investing capital gains in an OZ Fund? Perhaps regarding a specific type of capital gain not mentioned here? Contact a representative of the Four Points Funding team to learn more.
Disclaimer: Four Points Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.