OZ Podcast Series for Investors, Part 2: Eligibility of Gains and Timing of Investment

CATHERINE BAZLEY: Hello and welcome to Cherry Bekaert's podcast for Real Estate and Construction, where we discuss developing trends and market dynamics as well as tax and accounting tips that may impact you.

CATHERINE BAZLEY: We are discussing what you, an investor who has had some luck in the market or sold a business, can do to save tax dollars. People have heard of the Opportunity Zone Program at a high level and know there's some kind of tax play but are unsure what this means and how it impacts them.

CATHERINE BAZLEY: Our four-part series explores the Opportunity Zone Program. Today's focus is on the gains that are eligible for this program and the timing of the investment. I'm Katherine Basley, a self-proclaimed tax nerd who happens to be a tax partner in Cherry Bekaert's Atlanta office with 20-plus years of experience in the real estate arena.

CATHERINE BAZLEY: My co-host is Mike Elliott, a director in our Tampa office. Mike, why don't you tell listeners a little bit about yourself?

MIKE ELLIOTT: Thanks, Katherine. I've been practicing in the area of federal partnership taxation for 25 years, mostly in the real estate industry. My role now includes all industries, as I'm the lead internal partnership technical resource for the firm.

CATHERINE BAZLEY: As tax professionals, the most common question we get is: how can I save money on my taxes? With the introduction of the Opportunity Zone Program, there is a new avenue for investors to defer and reduce taxes. As an investor, when should I consider an Opportunity Zone investment?

MIKE ELLIOTT: That's an excellent question. First, it's best to think about the purpose of the program. It was created by the government as part of tax reform to attract investment from the private sector into areas that were struggling to recover.

MIKE ELLIOTT: The perception was that many wealthy investors had large unrealized capital gains and were hesitant to sell because of the tax ramifications. To encourage redeployment of that capital into alternative investments, the law created tax benefits to give investors an incentive to invest in the program.

MIKE ELLIOTT: The Opportunity Zone Program helps mitigate that tax burden by allowing those investors to defer recognition of those gains until 2026. Potentially, up to 15% of the original gains can be excluded permanently.

MIKE ELLIOTT: If you sold stock or sold assets from a business resulting in a significant capital gain, you can defer that gain until 2026 simply by rolling over the gain portion of your proceeds into a Qualified Opportunity Fund. We use the acronym QOF to refer to a Qualified Opportunity Fund.

MIKE ELLIOTT: Ideally, to take full advantage of the tax benefits available, you'd want at least a 10-year investment horizon. If you hold your investment in the QOF for at least 10 years, there would be no gain to be recognized on the ultimate sale of the QOF interest.

CATHERINE BAZLEY: What gains qualify for the Opportunity Zone Program? Can you give us a high-level overview and then a few examples?

MIKE ELLIOTT: Any capital gain qualifies. It doesn't matter whether it's short-term or long-term, or the amount of the gain. Any gain on S corporation or partnership property would qualify as well.

MIKE ELLIOTT: If you sold stock or sold assets from a business and that resulted in a capital gain, you can defer that gain until 2026 by rolling over the gain portion of your proceeds into a QOF.

CATHERINE BAZLEY: If I invested $100,000 in a penny stock and seven days later it's worth $2 million, would that gain qualify?

MIKE ELLIOTT: Absolutely. You would have a $1.9 million gain, and it doesn't matter that it is short-term. That gain would qualify, and you could roll over the entire $1.9 million into the program and receive the benefits.

CATHERINE BAZLEY: How about if I was the founder of a startup and a private equity group bought me out, either in full or partially? Would that qualify?

MIKE ELLIOTT: Assuming the gain is capital in nature, that would qualify. You could reinvest the gain portion of your proceeds into a QOF.

CATHERINE BAZLEY: One more example: if some friends and I start a partnership and that partnership invests in real estate or businesses and the real estate held by that partnership is sold, would that gain qualify?

MIKE ELLIOTT: Yes. If the assets were sold and the partnership realized a gain, you have a couple of choices. The partnership can take the gain portion of the proceeds and reinvest that into a QOF, in which case the partnership itself would become a QOF investor and receive the tax benefits.

MIKE ELLIOTT: Alternatively, if the partnership distributes the proceeds to you instead of reinvesting, you receive your allocable share of the gain. You can then reinvest your share of the gain into a QOF and receive the tax benefits individually.

CATHERINE BAZLEY: Timing is an important aspect of the Opportunity Zone Program. Can you explain the timing considerations?

MIKE ELLIOTT: Timing is critical. If you sell something directly and realize a gain, you can obtain the special benefits by rolling over the gain portion of the proceeds within the 180-day period that begins on the date of the transaction. The 180-day period is an important deadline.

MIKE ELLIOTT: If you're an investor in a partnership that sold real estate and you have an allocable share of gain from the pass-through entity, your timing rules differ slightly. By default under the law, your 180-day period begins on the last day of the partnership's tax year. It does not matter when during the year the partnership sold the asset; your 180-day clock by default starts on December 31 of that year.

MIKE ELLIOTT: Alternatively, you can elect to have your 180-day period start on the same date the pass-through entity's 180-day clock starts. For example, if the partnership sold something on June 1, 2019, you can elect to have your 180-day period for that gain start on June 1, 2019, giving you 180 days from that date to reinvest. You don't have to wait until December 31.

MIKE ELLIOTT: There is also another alternative for pass-through investors. Sometimes partners do not realize they have a gain until they receive a Schedule K-1 showing a large gain. You can elect to have your 180-day period start on the due date of the partnership's tax return, which generally is March 15 of the following year. That could give you a 180-day period starting on March 15, 2020 and ending on September 15, 2020, which extends beyond the year when the gain was realized.

CATHERINE BAZLEY: For listeners who are not tax professionals, what are some key thoughts or phrases to keep in mind?

MIKE ELLIOTT: First, timing is the most important. Remember, the gain must be rolled over within the applicable 180-day period, and the investor must elect to defer that gain on their tax return for the year in which it was realized to be eligible for the tax benefits.

MIKE ELLIOTT: Second, amounts invested in the Opportunity Zone Program after 2026 do not qualify for the tax benefits. The program was designed so investors needed to have money invested in the program by the end of 2026 to receive the benefits.

MIKE ELLIOTT: Third, keep the holding periods in mind. The original gain is deferred only until 2026, and on December 31, 2026, every investor who elected to defer their gain must recognize that deferred gain on that date.

MIKE ELLIOTT: There are additional benefits written into the law. If you've held your investment in the QOF for at least five years, you can permanently exclude 10% of the original deferred gain when you recognize it. If you held it for at least seven years, an additional 5% of the original gain can be excluded, for a total 15% exclusion.

MIKE ELLIOTT: To obtain the seven-year benefit, you would have had to have your money invested by December 31, 2019. If you invested in a QOF after 2019, the maximum permanent exclusion available as of December 31, 2026 would be 10% for a five-year holding period; you would not meet the requirement for the seven-year holding period.

MIKE ELLIOTT: Finally, only the equity in the QOF that has been held for at least 10 years qualifies for the permanent gain exclusion on the ultimate sale. You must have at least a 10-year time horizon for the investment to take full advantage of the program.

CATHERINE BAZLEY: Stay tuned for our next podcast, which will be released in the next couple of weeks, where Mark and Shannon will talk with us about key inclusion events.

CATHERINE BAZLEY: In the meantime, if you have any questions or need further information, please visit us at cd.com.