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Opportunity Zones: New Tax Deferral Opportunity

by Barrent Dahl

There is an exciting tax-saving opportunity for those investing in designated zones across the country, including within our own metro area. These zones are designed to encourage economic development and create jobs in areas with significant untapped economic potential.

Minnesota Is a Land of Opportunity Zones

Here Are Opportunity Zones in Minnesota - Redpath and Company

In accordance with H.R.1 Tax Cut and Jobs Act of 2017, Governor Dayton nominated 128 census tracts for designation as a qualified opportunity zone. On May 18, 2018, the U.S. Department of Treasury certified and formally designated these census tracts as qualified Opportunity Zones. See more information on Minnesota opportunity zones at https://mn.gov/deed/business/financing-business/tax-credits/opp-zones/

If you’ve sold a piece of property or an investment for a significant gain, you can defer the gain if you invest in a Qualified Opportunity Fund, and also in a Qualified Opportunity Zone, often within 180 days of triggering the gain. This will allow you to defer paying tax on the sale until December 31, 2026 (2027 tax filing season). Two main factors: you have to a) sell something for a gain, and b) you have to want to invest in something else. DOWNLOAD A FREE OPPORTUNITY ZONES .PDF

Opportunity Zone Basics

In order to take advantage of the Opportunity Zone program, participants need to invest in a Qualified Opportunity Zone Fund (QOF). A QOF is any investment vehicle organized as a domestic corporation or partnership for the purpose of investing in a Qualified Opportunity Zone (QOZ) property (other than another QOF). Any capital gain from the sale to, or exchange with, an unrelated person of any property held by the program participant(s) prior to 12/31/2026 can be deferred to the extent the gain is reinvested in a QOF.

  • You don’t have to live, work, or have a business in the zone. Generally, participants just need to invest in a Qualified Opportunity Fund;
  • Participants generally need to invest in a Qualified Opportunity Zone Fund within 180 days of realizing gains from a sale or exchange;
  • The opportunity fund must have 90% of its assets in Opportunity Zones;
  • To qualify, the property can’t be property previously used by anyone in the zone (unless it meets the substantial renovation test);
  • Recognized gain treated as capital gain for tax purposes is eligible to be deferred;
  • Holding the investment for 5 years allows a basis increase of 10% of deferred gain;
  • Holding the investment for 7 years allows a basis increase of 5% of deferred gain;
  • Deferral period ends on December 31, 2026, when the tax will become due; and
  • If held for 10 years, an election can be made to step basis in the property up to fair market value at the time of sale.

Opportunity Zone Example

For example, two business owners who are 50/50 shareholders sell their business for a $2 million gain. One of the shareholders wants to retire, but the other wants to invest in a new construction project in St. Paul.

Shareholder One takes the money and pays tax on their share of $1 million gain at a 33.65% tax rate. They will pay $336.5K in tax and retire with $663.5k of cash in their pocket.

Shareholder Two takes $1 million from the sale (equal to their gain), and invests into a QOF:

  • No tax is paid on the initial sale of the investment, and basis in the new property is $0;
  • If the property is held for 5 years, the basis is stepped up by 10% of the deferred gain; and
  • If the property is held for 7 years, there is an additional 5% basis increase.
At 12/31/2026, the tax deferral period is complete and tax will be due. If they still own the property, tax will be $286,025: $1 million original deferred gain minus the lesser of the gain excluded, or the fair market value over the basis of the investment (in this example, $150k additional basis), multiplied by a 33.65% tax rate. If they sell the property for $1.5 million after holding it for 10 years, no additional tax is due and they walk away with $1.5 million cash in their pocket.

The benefits of the Opportunity Zone in the example include:
  • Deferred gain until December 31, 2026;
  • Basis steps up to 10% after 5 years and another 5% after 7 years; and
  • $0 Tax on the sale of the Qualified Opportunity Zone property if the property is held for 10 years.
A Sample Calculation for an Opportunity Zone - Redpath and CompanyCopyright 2018 Redpath and Company. All Rights Reserved.

In the above example you would enjoy all of the following:

  • Eight years of deferred federal tax;
  • A 15% reduction of the deferred gain; and
  • $0 Tax on the sale of the Qualified Opportunity Zone property if the property is held for 10 years.

If you keep your money in an opportunity zone for a minimum of 10 years, there could be a tremendous opportunity for you. 

Barrent Dahl

Barrent Dahl

I’m a senior manager in the business tax service area at Redpath and Company, a top Midwest accounting firm in St. Paul, MN, where I assist clients in industries such as manufacturing, construction, real estate, and professional services with tax planning, preparation, and research. I have provided public accounting services since 2008 and have been at Redpath and Company since 2011.