The clock is ticking on an important benefit available through the federal Qualified Opportunity Fund (QOF) and Kentucky Opportunity Zone investment programs. Investing in a QOF before December 31, 2019 will allow you to take advantage of a 15% permanently excluded taxable gain if you hold the investment through December 31, 2026.
Generally, a capital gain realized can be reinvested (within 180 days) in a QOF which uses the capital to invest in economically depressed areas. The Tax Cuts and Jobs Act created a federal provision to encourage investment in these areas throughout the United States. There are over 140 designated zones located in Kentucky. Individuals, C corporations, S corporations, partnerships, trusts, estates, regulated investment companies and real estate investment trusts are eligible to participate in Qualified Opportunity Fund investments.
A capital gain realized in 2019 and reinvested in a Qualified Opportunity Fund before December 31, 2019 can be deferred without being taxed until the investment is sold or December 31, 2026, whichever comes first. Holding the investment for seven years results in a 15% permanent exclusion from taxable income. Therefore, the investor would be taxed on 85% of the gain if invested before 12/31/2019 and held through 12/31/2026.
Realized capital gains reinvested after December 31, 2019 and before December 31, 2021 would still be deferred and could be eligible for a 10% permanent exclusion from taxable income if held for five years. In addition, the appreciation on an investment held for 10 years would be permanently excluded from taxable income.
For example, say you sold stock in 2019 that resulted in a $750,000 capital gain to an unrelated third party, and then reinvest the capital gain amount before 12/31/19 in a QOF that plans to build an apartment complex located in an Opportunity Zone. The apartment complex is successful, the investment value increases, and you hold your investment for the 10 years. The $750,000 gain would be deferred until 2026. Your 2026 personal tax return would include a taxable gain of $637,500. You would save around $41,000 in taxes if taxed at the maximum 37% tax rate. Your $750,000 investment is worth $2,000,000 after 10 years, which is an appreciation in value of $1.25 million. This $1.25 million will be a permanent exclusion from taxable income since it was held 10 years.
At DMLO CPAs, we are committed to being proactive in planning to minimize the tax impact of your earned income. Please contact us if you would like to discuss the potential tax benefits of investing in a Qualified Opportunity Fund.