With small businesses accounting for a large percentage of the U.S.Economy, these companies are eligible for specific tax incentives, including deferred tax gains that some small business owners may not be aware exist. In the case of Opportunity Zones (OZ), where a business is established can make a huge impact on how capital tax gains are managed.
What is an Opportunity Zone (OZ)?
Opportunity Zones (OZ) were created in 2017 under the Tax Cuts and Job Act (TCJA) as a way to serve underprivileged areas and stimulate local economies. The intent of this tax code is to incentivize investors to pour capital into these socioeconomically-challenged regions to support businesses which will in turn create jobs and revitalize neighborhoods. When investing in a designated zone, taxpayers are able to recognize deferred capital gain through December 31, 2026 when the tax code is set to expire.
At the time TCJA was imposed, 761 areas—found around the United States—were designated as opportunity zones. According to the White House Opportunity and Revitalization Council, there are now 8764 opportunity zones in all 50 states, the District of Columbia and five U.S. territories.
See a complete list of Opportunity Zones across the US.
What is a Qualified Opportunity Zone Business?
There are many advantages to starting a business in an Opportunity Zone, including the ability to access capital from a Qualified Opportunity Fund (QOF). Having easily-accessible capital is something many companies need to help their businesses launch and continue to grow.
In order to qualify as an opportunity zone business, the following criteria must be met:
- At least 50% of gross income must be earned within the Qualified Opportunity Zone
- Employees must work within the Qualified Opportunity Zone
- The business must be an “eligible business” and must not be in an excluded industry.
What is a Qualified Opportunity Fund?
Qualified Opportunity Funds are investment vehicles used to provide capital to opportunity zone businesses. They are set up as either a partnership or corporation, must be organized to operate in a Qualified Opportunity Zone property, and must hold 90% of its assets in a Qualified Opportunity Zone Property.
Incentives for Investors
According to the IRS,
“Opportunity Zones offer tax benefits to business or individual investors who can elect to temporarily defer tax on capital gains if they timely invest those gain amounts in a Qualified Opportunity Fund (QOF). Investors can defer tax on the invested gain amounts until the date they sell or exchange the QOF investment, or Dec. 31, 2026, whichever is earlier.”
Investors can defer tax on their previous eligible gain if an equivalent amount is reinvested in a Qualified Opportunity Fund in a timely manner. They can defer until December 31, 2026 or on the date the investment in the QOF is sold or exchanged. If the investment in this qualified opportunity fund is held for at least 5 years, the taxpayer can exclude 10% of the gain. This percentage increases (or “steps up”) to 15% after 7 years.
After holding the investment in a qualified opportunity fund for at least 10 years, the taxpayer becomes eligible for the second benefit of this code. The basis of the QOF can be adjusted to its fair market value on the date of sale of said QOF. In the end, the appreciation of investment made in the qualified opportunity fund can be tax-free.
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