For business owners interested to learn how to defer taxes when selling a business, there is a proven option that offers significant tax savings while simultaneously making a meaningful impact on local communities: Qualified Opportunity Zones (QOZs).
Passed as part of the Tax Cuts and Jobs Act of 2017, QOZs are land tracts designated by the U.S. Treasury Department and Internal Revenue Service. To incentivize private investment in these communities, the QOZ legislation created tax breaks to investors who make qualified long-term investments that have the potential to promote economic growth in these zones. For investors to participate and reap the tax benefits, they need to invest in a QOZ fund within 180 days of a capital gain event.
In simplest terms, QOZs offer business owners and investors a combination of tax deferral and tax avoidance. The two main principals are:
- Deferring of current capital gains tax owed until 2026
- Tax-free growth of the QOZ investment if held for 10 years
Deferring current capital gains taxes
The deferral opportunity presented by a QOZ investment can be quite appealing in that you can defer paying taxes by rolling over capital gains from any appreciated asset, such as the sale of a business, within 180 days of that sale. And if that gain was realized within a partnership, an LLC, or an S-corporation of which you are a member or shareholder, you have until early September of the following year to reinvest in a QOZ fund and defer your tax bill. For example, investors that have 2021 gains from a K-1 have until Sept. 9, 2022, to reinvest into a QOZ fund.
Investors with capital loss carryforwards also have options. They can simply use their carryforwards for any capital gain generated and not pay tax. Or they can invest the gains in a QOZ fund and utilize the carryforward in 2026. The latter option allows the investor to receive the additional benefit of a QOZ fund: tax-free growth of the QOZ investment if held for 10 years. In addition, there may be state tax issues that limit the use of a capital loss carryforward.
Of note, the nature of the deferred gain will not change, so a rolled-over long-term capital gain, while deferred and not currently taxable, will still retain its character as a long-term capital gain in the year of inclusion.
Tax forgiveness of capital growth after 10 years
The largest tax-saving potential for a QOZ investment is the avoidance of paying any tax on the qualified investment after having held it for at least 10 years. As desirable as tax deferral might be, it serves to merely postpone the inevitable for a few years. On the contrary, taking a disciplined approach to a QOZ investment and keeping it intact for 10+ years would mean a complete tax forgiveness on the post-rollover appreciation portion, essentially making it a tax-free investment. As most states have conformed to the U.S. Treasury on the treatment of Opportunity Zones, potential tax savings could be significant. And the law allows investors to keep the investment beyond the 10-year mark if they so choose, with January 2048 as the maximum statutory threshold before which the investment should be liquidated.
It’s important to mention proposed QOZ legislation that could become part of the upcoming tax extender’s bill. Overall, the proposed legislation is favorable for the QOZ program. It would extend the program by two years, allow for an extra two-year deferral, and allow for reductions in the deferred capital gains tax.
In summary, QOZ investments offer significant tax benefits, but business owners and other investors should work with a qualified advisor to analyze the various aspects of the program to make an informed decision on whether, when, and how much to invest.
To further explore QOZ invetsments and their significant tax benefits, please email [email protected].
