Opportunity Zones: What You Need to Know
By: Lucas Whelan
Key Takeaways:
• Capital gains from carried interest are eligible for Opportunity Zone benefits.
• The 10% step-up in basis benefit expires on 12/31/21.
• Investors need to invest on or before 12/31/21.
M&A activity and valuations are at all-time highs. These two factors have created significant capital gains for fund managers that have had successful exits in 2021. Qualified Opportunity Zone (QOZ/OZ) investments can be a powerful tax planning tool to defer and reduce capital gains tax bills. For understanding eligibility and qualifications of your investment, we strongly recommend consulting your tax professional. What you need to know is that QOZ investments should be considered as the end of the year nears and one of the OZ program benefits expires.
The benefits of the OZ program can be distilled down to; defer, reduce and pay zero.
• Defer: Capital gains can be deferred until December 31, 2026, with the related tax payable in 2027.
• Reduce: Investors who hold an OZ investment for five years can exclude 10% of the deferred gain (i.e., they only pay tax on 90% of the gain). To receive this benefit, an investment must be made on or before December 31, 2021.
• Pay Zero: Investors who hold their investments in OZs for at least 10 years face no taxes on any appreciation in value of the investments when sold.
To better understand and visualize the tax benefits of QOZ investments, the analysis below compares a non-OZ and an OZ investment from a $1,000,000 capital gain. Depicted in the bottom three rows are the tax benefits from the reduce and pay zero benefits, which comes out to ~$312,835. There are other potential benefits that we haven’t ascribed a value to such as, TVM of deferring tax payment and no depreciation recapture.
• Reduce: Potential benefit of $23,800, the difference between paying the full capital gain tax of $238,000 this year (23.8% on $1,000,000 gain) with a non-OZ investment and the reduced capital gain tax of $214,000 (23.8% on $900,000 of taxable gain) with an OZ investment.
• Pay Zero: Potential benefit of $289,035, the difference from paying capital gains at exit of $289,035 (23.8% on $1,214,431 appreciation) with a non-OZ investment and paying ZERO capital gains tax at exit on the OZ investment.
QOZ investments can be a useful tool for tax planning and as a long-term tax-advantaged real estate investment. Eligibility and qualifications for OZ benefits should be assessed by your tax professional prior to committing to or making any QOF investment. There are different investment alternatives in the QOF space, mainly consisting of diversified QOF funds and single-asset QOF investments.
CLA is a leader in the Opportunity Zone space and provides services across the OZ spectrum. On the front-end, our M&A advisory and investment banking practice helps clients sell their businesses, which more often than not creates large capital gain events. Our wealth advisory practice has advised on more than $200 million of capital invested in OZ funds. Our capital markets group works specifically with our real estate clients to fund their single-asset OZ projects, and to date has raised over $350 million of OZ capital from institutional investors. CLA also conducts OZ compliance and testing, structuring consultation, fund administration, and other fund services for sponsors of OZ projects.
For more information please view a recent CLA webinar or reach out directly.
Craig Arends is a principal at CLA and is the managing principal of CLA's private equity practice. Craig brings a concentration of experience in providing accounting and transaction structuring advice for leveraged recapitalizations, purchase accounting and SEC reporting, assessing quality of earnings, and GAAP accounting. He has far-reaching experience with critiquing financial models and reviewing target companies' financial performance to identify cost reductions and/or operating efficiencies Craig has more than 30 years of experience in public accounting serving public companies, private equity groups, and companies, including a term as principal in charge of a Big Four Capital Markets Group in Moscow, Russia. He has led financial accounting due diligence projects for private equity investor groups and venture capital funds, primarily in the technology, communications, and manufacturing industries, as well as assisting with Foreign Corrupt Practice Act matters ranging from investigation of payments made, validation of compliance with corporate policies, and review of proposed transactions to ensure compliance. When not working, Craig enjoys watching any sports, but his most favorite are baseball, football and soccer.
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