You may have assumed the tax law that took effect last year was a boon to people with ultra-high earnings. Yet many of them received only a small reduction in their tax rate — and some will be paying more under the new law.
An extraordinary provision added by the Tax Cuts and Jobs Act makes it possible for taxpayers to defer almost any kind of capital gain and potentially secure additional tax benefits if they invest in a qualified opportunity fund. (Proposed regulations make exceptions for gain from section 1256 contracts or offsetting positions.) You need to make this election during the 180-day period beginning on the day you have the gain, and then show on your tax return that you elect to invoke this provision. Your gain, up to the amount you invest, will not be taxable that year, but instead will become taxable when you sell this investment, or on December 31, 2026, if the investment remains unsold on that date.
Depending on how long you hold this investment, some of that gain may disappear. After five years your basis is increased by 10% of the amount that was deferred, eliminating 10% of the gain from the original sale. Another 5% of that gain disappears if your holding period stretches to seven years. As a final kicker, reaching the ten-year milestone lets you avoid paying tax on any gain from an increase in the value of this investment during your holding period.
A qualified opportunity fund has to be at least 90% invested in properties and businesses in certain low-income areas or adjoining areas. That’s the underlying idea: to revitalize these areas by attracting investment dollars. Those dollars are not targeted to particular types of projects, however. Funds will pursue properties and businesses that provide the highest returns for their investors.
As written in the law, this tax benefit is available to all taxpayers. Anyone who has a capital gain of almost any kind can defer reporting the gain by investing in one of these funds. Yet as of this writing, these investments are available only to accredited investors—those who make over $200,000 per year (or $300,000 with their spouse), or have net worth, excluding their home, above $1,000,000. Members of the general public can’t buy in because the funds haven’t gone through the lengthy, expensive process of getting their offerings registered with the SEC. At least one firm has made an SEC filing that could lead it to become publicly traded as a qualified opportunity fund REIT, so this deferral benefit could eventually become available to all investors. For now, however, this extraordinary new tax benefit is reserved for the wealthy.
Articles on year-end tax planning for investors inevitably mention the opportunity to harvest losses from stocks and other securities that may have declined in value. Recent stock market declines have increased the potential value of this opportunity, along with the importance of understanding the wash sale rule, which can stand in the way of efforts to harvest losses while maintaining a consistent investment strategy. No doubt you’ve seen brief summaries of this provision, but there’s a lot more to the wash sale rule than meets the eye. Get the full details here: