What is a Tax Advantaged Qualified Opportunity Fund?

March 13, 2019
  • facebook
  • linkedin
  • twitter
  • google plus

Most financial experts call them Qualified Opportunity Funds (QOFs). They are also known as Opportunity Zones. Whatever you want to call them, there’s a good reason “opportunity” is always in the title. These new investment funds are one component of the Tax Cuts and Jobs Act of 2017 that savvy investors are using to create excellent long-term tax advantages.

The Major Tax Advantages

Qualified Opportunity Funds were created as part of the tax overhaul as a way to encourage investment in the country’s less economically fortunate areas. Congress along with state governments put together these opportunity zones with built-in tax benefits as a way to entice investors to invest capital into these areas for economic development. Along with it comes some significant tax benefits.

Here are the primary tax advantages of Opportunity Funds:

  1. Tax Deferral On Gain From A Prior Investments Reinvested in a QOF An individual is eligible is able to make an election to defer the gain on the sale or exchange of a property to the extent the gain of the investment was reinvested into a QOF within 180 days. This means that one can reinvest taxable sale proceeds into a QOF and avoid capital gains tax of 15-20%.
  2. A Basis Step Up on Gains Reinvested – If an investor holds the new QOF investment for 5 years, they are able to increase their cost basis in the QOF by 10% of the original deferred gain they invested. If they hold it for seven years, they are able to increase their basis in the QOF by 5% more for a total of 15%. This means that the investor can actually reduce the amount of gain that will ultimately be taxable by 15% of the gain itself.
  3. Tax Deferral – As long as the funds are invested in the QOF, all taxes on capital gains invested are tax-deferred.
  4. Long-Term Tax-Free Growth – If the investment in the Qualified Opportunity Fund is held for more than 10 years, the capital gains become completely tax-free. If the investment is held for less than 10 years, only a percentage of your capital gains will be tax-deferred.

Increased Potential ROI

Essentially, the number of capital gains you can eliminate and/or defer will depend on how long you stay invested in the fund. If you cash out in less than 10 years, there will be a certain percentage you can defer, along with some other caveats that you will want to discuss with your tax advisor. Theoretically speaking, there is excellent potential for a greater return on investment compared to a traditional investment. Some experts project as much as two times the potential after-tax ROI for people who stay invested in a Qualified Opportunity Fund for 10 or more years.

Many real estate investors are seeing the appeal of Opportunity Funds. As long as the investments are located in qualified low-income zones, other key criteria are met and taxes are filed correctly, certain real estate investments might be considered QOFs and allow for tax deferral of capital gains.

Pros & Cons of Opportunity Funds

As with any new investment strategy, there are some pros and cons. The pros include:

  • Defer, reduce and eliminate taxes through Opportunity Fund investments
  • Continue to make money with new investments
  • Help revitalize less fortunate communities

The potential cons of Opportunity Funds include:

  • Requires patience to see full 10-year tax-deferral benefits
  • Illiquid investments (difficult to pull money out early)
  • The government may change tax law again in the next 10 years
  • Increased investment and tax paperwork
  • New developments in low-income areas can pose more risk

Professional Wealth Management

If you want to learn more about Qualified Opportunity Funds that you can invest in for long-term tax benefits, talk with your tax planner and financial advisor. Illumination Wealth is here to help you with all your important financial decisions when it comes to taxes, real estate, stocks, retirement savings and other financial planning strategies. Contact us today to get started on the road to true financial independence.