By Benjamin Lau, Chief Investment Officer
A little-known proposal in President Trump’s Tax Cuts and Jobs Act (TCJA) last year included a provision that seems extremely appealing for many investors. In an attempt to encourage new investments into underdeveloped areas of America, the government is offering substantial tax benefits. Seems too good to be true, right? Details are still emerging from the government, but Friday’s proposal from the IRS affirms the benefits and clarifies many of the rules surrounding this new opportunity.
This all focuses on when the TCJA created almost 9,000 “opportunity zones” across all 50 states (see map from EIG.org). These areas are loosely defined as lower-income markets. One eligible opportunity zone is near the University of Southern California where the poverty rate is 88 percent. The hope, of course, is that the investments will encourage business creation and jobs in these areas.
The big benefit in the new law allows zone investors to defer their capital gains and, in some cases, avoid it almost completely. For example, if you were interested in investing $100,000 into a real estate project next to USC and you wanted to fund it by selling $100,000 of Apple stock, which you bought for $60,000, normally you would owe capital gains taxes on the $40,000 profit. But since you’re investing in a qualified opportunity fund, you could defer the capital gains taxes. If you hold the fund for five to seven years, a certain amount of the capital gain tax is reduced. If you hold the fund for 10 years or more, then almost all the capital gains tax is wiped clean.
At first glance this seems too good to be true; getting a (large) tax break for doing good? While the tax benefit is substantial, we still have to consider if the underlying investment would generate enough returns to compensate for the (likely) increased risk.
We are likely at the start of this whole process. Friday’s announcement from the IRS clarified many things as fund companies and developers start working on this. Apriem has been following this opportunity for a while now and will continue to perform due diligence. If you have any interest or questions, please reach out to your wealth manager.