OZ Benefits

Investors in an Opportunity Zone are eligible to receive significant tax benefits in several ways:

(1) Federal and possibly State Capital gains deferral (see Conforming States).

(2) Partial forgiveness via step-up in basis.

(3) Capital gains exclusion applying to additional gains on the OZ investment itself, resulting in complete forgiveness on incremental gains.

To fully understand the benefits, let’s take the example of an individual with $1,000,000 in capital gains who chooses to invest in an OZ fund, and the investment appreciates to $2,000,000 over a 10-year period. 

Capital Gains Deferral

First, the investor benefits by being able to defer federal and possibly state capital gains tax on the initial $1,000,000 until the OZ “Recognition Date” — the date of the disposition of the OZ property, or December 31, 2026, whichever occurs first.  By virtue of deferring the initial capital gains tax, the investor is able to invest the full $1,000,000 instead of the $762,000 that would be left after paying the normally required capital gains tax (assuming a 23.8% tax rate).

Partial Forgiveness via Step-up in Basis

Second, by virtue of OZ investment, the investor’s tax basis for his or her deferred gains — the initial $1,000,000 — starts at zero.

• After five years, the taxable basis increases by 10%, or $100,000 in our example.

• After seven years, the taxable basis increases an additional 5%, or $150,000 total in our example.

As a result, after holding the investment for at least seven years, the investor’s cost basis is $150,000 and his/her capital gain is $850,000 — not the original $1,000,000.  The $150,000 difference is “forgiven” when the investor pays capital gain taxes on the OZ Recognition Date.

Capital Gains Exclusion

Arguably the most compelling feature of the OZ program. If the investor holds the OZ investment for at least 10 years, there is no tax due on the appreciation of the investment from the time of the initial investment in the OZ through the disposition of the Property. In other words, the investor can elect to step-up the basis in the OZ to fair market value and not pay any tax on the gains received while invested in the OZ. As a result, there is no tax due on the $1,000,000 gain on the OZ investment — the difference between the $1,000,000 initial investment and the $2,000,000 market value in 10 years assuming a 2.0x multiple on the investment.