When I finished training, I was focused on getting rid of $300k worth of student loan debt and developing a solid financial plan. Unfortunately, most high-income professionals miss out on a key part of planning for building wealth: a tax reduction plan.
If you know that your BIGGEST expense is going to be your federal taxes (from trading time for money), wouldn’t it make sense to sit down with an advisor and create a specific tax savings plan?
I wish I had early on.
Most of us get out of school focused solely on one thing, making money. I remember someone in my dental school class was asked about taxes early on in his career. He said, “Taxes? Who cares about taxes? I want to be Rich! I’ll make plenty of money to buy whatever I want and pay my taxes with no problem!”
But once we get older and somewhat wiser, we naturally start to slow down. And it’s at that point we’ll start to pay more attention to expenses cutting into our income so we can work less yet still make roughly the same.
Before I go any further a quick disclaimer: I’m a periodontist and NOT a tax advisor. Don’t take any information in this article as financial or legal advice. Consult your CPA or financial advisor for a tax reduction plan.
Now that’s out of the way….
If you’re looking for a way to reduce your tax bill, I’ve got something that may interest you: Opportunity Zone Funds.
These are investments that allow you to defer any unrealized capital gains you earn from the investment until 2026.
In addition, if you hold the investment for at least 7 years, you may receive a reduced tax rate on the eligible capital gains.
Opportunity Zone Funds are a great way to invest in areas that may be underserved by traditional investment vehicles. By investing in these funds, you can help to:
- revitalize communities
- spur economic development
Additionally, Opportunity Zones provide investors with the potential for high returns on their investment.
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Sign up for my newsletterWhat Is an Opportunity Zone?
An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Congress created the Federal Opportunity Zone Program as part of the Tax Cuts and Jobs Act of 2017 to encourage long-term investments in low-income urban and rural communities nationwide.
Opportunity Zones are designated by a state governor, in consultation with their state economic development agency and local leaders. There are more than 8,700 designated zones nationwide.
What Are Opportunity Zone Funds?
A Qualified Opportunity Zone investment is designed to encourage an investment in economically-distressed communities. The fund must be organized as a partnership or corporation, and at least 90% of its assets must be invested in Qualified Opportunity Zones.
These zones are designated by the government as areas experiencing a decline in economic growth. In order to qualify for the program, a fund must invest in Qualified Opportunity Zones within a prescribed period of time. The benefits of a Qualified Opportunity Zone fund investment include tax incentives and the potential for capital appreciation.
3 Tax Benefits Of Investing In Opportunity Zone Funds
The qualified opportunity zone designation provides 3 key tax benefits for investors:
1. Deferral
One of the major tax benefits of investing in a Qualified Opportunity Fund investment is the deferral of capital gains taxes. This benefit allows a temporary tax deferral on any capital gains by investing those gains in a qualified Opportunity Zone fund within a 180-day period of realizing the gain. If you have realized a capital gain from the sale of an asset or an investment, you can invest those gains in a qualified Opportunity Zone Fund and defer paying taxes until 2026.
In addition, if you hold your investment in the fund for at least five years, you’ll receive a 10% reduction in your capital gains taxes. If you hold your investment for at least seven years, you’ll receive a 15% reduction.
2. Exclusion
This benefit allows investors to exclude from their taxable income any capital gains from the date of sale or exchange of an investment in a QOF, if the investment is held for at least 10 years.
3. Step-up in basis
Investments made in a Qualified Opportunity Zone Property are also eligible for a step-up in basis. This means that the value of your investment will be increased by the amount of any appreciation that occurs while it is held in the fund. This can provide a significant boost to your returns when you eventually sell your investment.
By taking advantage of these tax advantages, investors can significantly reduce their tax liabilities and increase their returns on investment.
How Much Gain Can Be Deferred?
You can elect to defer as much or as little gain as you want as there’s no limit on the amount of deferred gain.
For example, if you choose to sell a property for $2.5 million with basis of $1,000,000, you’ll have a gain of $1.5 million. You can choose to defer all gains by investing all of it in a QOF and then making an election on a filed return.
On the other hand, you may consider deferring as little of the gain as you choose. For instance, you may want to only defer $200,000 of the gain by investing only that amount in a QOF.
Different Types Of Opportunity Zone Funds
When it comes to investing in an Opportunity Zone, there are a few different types of funds to consider.
#1. Qualified Opportunity Zone Fund (QOZF)
This fund is created by investment sponsors and must be certified by the IRS. In order to be eligible for certification, the fund must be organized as a corporation or partnership and must invest at least 90% of its assets in Qualified Opportunity Zone real estate projects.
QOZFs also have the benefit of being able to defer capital gains taxes on investments made before December 31, 2026.
#2. Qualified Opportunity Zone Business (QOZB)
Unlike a QOZF, a QOZB can be any legal business entity, including sole proprietorships and LLCs. However, similar to a QOZF, at least 70% of a QOZB’s assets must be invested in a Qualified Opportunity Zone.
Additionally, these funds must derive 50% or more of their gross income from active business operations within the zone.
What To Look For When Choosing An Opportunity Zone Fund
As a general rule, when it comes to investing in an Opportunity Zone Fund, there are a few key factors to consider.
#1. Perform research and due diligence on the fund manager.
Ask yourself questions such as:
- What is their experience managing similar investments?
- What is their track record?
#2. Take a close look at the target areas the funds invest in.
- What is the market outlook for these areas?
- Are they stable or gentrifying?
- What is the potential for growth?
#3. Weigh the risks and rewards of the investment.
- What are the federal tax benefits?
- What are the risks of investing in these areas?
By carefully considering these factors, you can make an informed decision about whether an Opportunity Zone Fund is right for you.
Conclusion
Investing in Opportunity Zone Funds can offer significant tax benefits and the potential for high returns. However, it is important to do your research and due diligence before investing.
Look for experienced fund managers with a track record of success and invest in stable or gentrifying areas with growth potential. By carefully considering these factors, you can make an informed decision about whether an Opportunity Zone Fund is right for you.
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