The Qualified Opportunity Zone: A Limited Opportunity for Investors to Defer Capital Gains

By: Giev Justin Askari, Senior Wealth Planner, HSBC Private Banking

What are Qualified Opportunity Zones? 
The 2017 Tax Cuts and Jobs Act (TCJA) created a new tax incentive surrounding investments in Qualified Opportunity Zones (QOZs).  By investing in a business or fund that is eligible to take advantage of this limited opportunity, taxpayers can defer certain capital gains until 2026, and may qualify for up to 15% of the deferred tax liability to be excluded from recognition altogether (depending on when the eligible investment was made). 

Under the new law, any gain from the sale or exchange of property to an unrelated person that is invested in a Qualified Opportunity Fund (QOF) is excluded from the income of the taxpayer until either the investment is sold, or December 31, 2026.  The eligible investment must be made within 180 days of the date of sale (certain exceptions apply for gains received from interests in partnerships or other pass-through entities). 

A QOF is any corporation or partnership that meets the requirements set forth for investing in a QOZ.

In addition to deferral, the taxpayer can permanently exclude 10% of the deferred gain if the investment is held more than five years, and can permanently exclude an additional 5% of the deferred gain (15% in total) if the investment is held more than seven years.  If the investment is held more than ten years, 100% of the post-acquisition gain is excluded upon the eventual sale. 

How does it Work?
As a result of selling his business, Mr. Smith will be recognizing $10,000,000 of capital gains.  Instead of recognizing the capital gains, however, Mr. Smith invests in a QOZ within 180 days of the date of sale.  After five years of holding his investment in the QOZ, the cost-basis in his investment is increased by 10% ($1,000,000).  After seven years of holding his investment in the QOZ, the cost-basis of his investment is increased by an additional 5% ($500,000). 

On December 31, 2026, Mr. Smith is required to recognize the remaining deferred $8,500,000 of capital gains (the originally deferred $10,000,000, less the cost-basis increase of $1,500,000).

After holding the investment for more than 10 years, Mr. Smith sells his interest in the QOZ for $30,000,000, and the entire proceeds from the sale are received tax-free because he held the investment for more than 10 years. 

The Potential Upshot for Business Owners and Investors?
This is potentially a great opportunity for business owners planning on selling their business, or investors who want to defer the recognition of a large capital gain.  However, taxpayers who want to obtain the full advantage of the law should act quickly.  In order to obtain the full 15% exclusion from deferred gains, funds must be invested in a QOF by December 31, 2019.

Giev Justin Askari is a Senior Wealth Planner with HSBC Private Banking.  The views expressed herein are his own, and do not necessarily represent the views of HSBC.  This document is for informational purposes only.  The data contained herein is not, and should not be, construed as an offer to sell or solicitation of an offer to purchase or subscribe to any financial services product or investment product.  For more information, he can be reached at giev.j.askari@hsbcpb.com.

Compliments of HSBC,a  member of the EACCNY