Opportunity Zones were created by the Tax Cuts and Jobs Act of 2017 with the purpose of promoting investment in economically distressed areas of the United States. Investors in Opportunity Zones can benefit from significant tax advantages, including the deferral and reduction of capital gains taxes. This blog post will focus on three key benefits of investing in an Opportunity Zone:
Capital Gains Tax Reduction
Cost Segregation Studies
Avoiding Depreciation Recapture
One of the primary benefits of investing in an Opportunity Zone is the reduction of capital gains taxes. If an investor sells an asset such as stocks, real estate or a business and realizes a capital gain, they can defer the payment of capital gains tax by investing the proceeds in a Qualified Opportunity Fund (QOF). The QOF must then invest in a designated Opportunity Zone within 180 days of the sale of the asset.
If the investor holds the QOF investment for at least five years, they will receive a 10% reduction in the amount of capital gains tax owed. If they hold the investment for at least seven years, the reduction increases to 15%. In addition, if the investor holds the QOF investment for at least 10 years, any capital gains realized on the appreciation of the QOF investment will be tax-free.
To illustrate the potential savings from investing in an Opportunity Zone, consider the following example. Suppose an investor sells a rental property for a capital gain of $1 million. If they reinvest the proceeds in a QOF and hold the investment for at least seven years, they will receive a reduction in capital gains tax of $150,000 (15% of $1 million). If they hold the investment for at least 10 years, any capital gains realized on the appreciation of the QOF investment will be tax-free.
Another benefit of investing in an Opportunity Zone is the ability to take advantage of cost segregation studies. A cost segregation study is an analysis of the components of a commercial property to determine their tax classification and depreciation schedule. By breaking down the property into its individual components, such as HVAC systems, plumbing, and electrical systems, a cost segregation study can accelerate the depreciation schedule for certain components, resulting in significant tax savings.
For example, suppose an investor purchases a commercial property in an Opportunity Zone for $5 million. Without a cost segregation study, the property would be depreciated over 39 years. However, a cost segregation study may identify components that can be depreciated over a shorter period, such as five or seven years. This can result in significant tax savings over the first few years of ownership, as the investor is able to take larger depreciation deductions.
Finally, investing in an Opportunity Zone can help investors avoid depreciation recapture. Depreciation recapture is a tax on the depreciation deductions taken on a property over the course of ownership. When an investor sells a property, any depreciation taken must be recaptured and taxed at a higher rate than the capital gains tax rate.
However, if an investor holds an Opportunity Zone investment for at least 10 years, any capital gains realized on the appreciation of the investment will be tax-free, including any depreciation recapture. This can result in significant tax savings compared to traditional real estate investments.
Investing in an Opportunity Zone can provide significant tax benefits to investors, including reductions in capital gains tax, the ability to take advantage of cost segregation studies, and the avoidance of depreciation recapture. However, it is important to remember that Opportunity Zone investments are inherently riskier than traditional investments, as they are often made in economically distressed areas. Investors should conduct thorough due diligence and work with experienced professionals to ensure that they are making informed investment decisions.
This is just one of the many factors that makes investing in the Smoky Mountain so appealing. Much of the new development in the area is being completed in our opportunity zone. Including the new luxury STR development The Lodges at Reedmont. The Lodges at Reedmont sit just minutes from the parkway and walking distance to Soaky Mountain Water Park and have direct views of the Smoky Mountains and downtown Sevierville. Check out the sales kit or get connected with an agent to find out more about this new development opportunity.
Also, if you still have questions regarding opportunity zones, funds, or other tax strategies we have a CPA & Cost Segregation Specialist on staff who can guide you through the process today. Get connected with Matt Tatum today for more information.