The business landscape is ever evolving as many owners are selling their businesses or restaurants or retiring. The upside is these business owners are often realizing a significant return on their life’s investment. The downside is a large capital gains tax bill is looming on the horizon.
There is an option that can provide a win-win. Investing in a Qualified Opportunity Fund, or QOF, provides a way to reinvest a significant capital gain and defer the tax on that gain, while at the same time invest in an area in need of revitalization by bringing new businesses and jobs.
What is a Qualified Opportunity Fund?
A Qualified Opportunity Fund is a way for a corporation or partnership to invest at least 90 percent of its assets in a Qualified Opportunity Zone, which is an area of low income in need of rehabilitation. The Opportunity Zones program was established as part of the 2017 Tax Cuts and Jobs Act to encourage private investment in low-income areas.
What is the benefit of investing in a Qualified Opportunity Fund?
In addition to helping to revitalize a depressed area, there could be significant tax benefits for the investor.
The primary benefit is that investors in a Qualified Opportunity Fund defer paying taxes on their capital gains until Dec. 31, 2026, if the capital gains are invested in a Qualified Opportunity Fund within 180 days of the sale or exchange that created the capital gain.
The longer the investment in the QOF is held, the tax on that capital gain is also reduced. For instance, 10 percent of the gain may be excluded permanently if the investment is held for five years. That increases to 15 percent exclusion if held for seven years during the time period ending Dec. 31, 2026.
Further, any gains realized in an investment held in a QOF for more than 10 years would pay no federal tax on those gains.
Example: John purchased five restaurants for $5 million. It’s now 17 years later, and he sells his restaurants for $15 million. John invests the $10 million gain in a Qualified Opportunity Fund, which invests in a Qualified Opportunity Zone in his state. He will defer the tax on $10 million gain until Dec. 31, 2026.
If John holds onto his interest in the QOF for at least five years, on Dec. 31, 2026, he will only be taxed on 90 percent of the original gain. If he has retained that interest in the QOF for at least seven years, he will only be taxed on 85 percent of that gain.
When John sells his interest in the QOF 11 years later for $22 million, he pays no federal tax on the $12 million gain.
To take full advantage of the potential tax benefits of a Qualified Opportunity Fund, investments of capital gains into QOF’s must be made by Dec. 31, 2019.
Please contact your tax manager today to let us know if you would like to learn more about this opportunity.
Tamra Newman, CPA, CVA, is a Tax Manager with Antares Group, Inc. She can be reached at firstname.lastname@example.org.