Opportunity Zones are a tax incentive created by the Tax Cuts and Jobs Act otherwise known as the Trump tax law. These incentives are meant to provide an avenue for the taxpayer to defer capital gain income while encouraging investment in economically depressed areas. If the taxpayer jumps through the necessary hoops significant tax savings is possible.
Great! Now how do I go about reducing my tax bill?
First, within 180 days of the sale that generated the capital gain, the capital gain is plowed into a qualified opportunity fund. There are companies out there that administer qualified opportunity funds and ensure the necessary requirements are met. The qualified opportunity fund will then invest in one of the qualified Opportunity Zones.
Kansas Opportunity Zones can be found here: https://www.kansascommerce.gov/programs-services/federal-opportunity-zones/opportunity-zones-map/. The Missouri Opportunity Zones are found here: https://ded.mo.gov/content/opportunity-zones. When looking at both maps you will see urban and rural areas that are qualified Opportunity Zones. There are more than 8,700 designated Opportunity Zones across the country.
The law spurs taxpayers to leave the investment in the qualified opportunity fund. The longer the investment is left in the fund, the more tax the taxpayer is able to avoid. When the deferred capital gain is contributed to the qualified opportunity fund there is no basis in that initial investment. Basis is what’s deducted from the selling price to determine the capital gain. So the basis is zip, zero, nada up to the 5 year mark.
Example 1 – Patrick sells his PayPal stock for a gain of $10,000 on July 2, 2018. He then turns around on October 5, 2018 and invests the $10,000 into a qualified opportunity fund. He decides to exit and sell his investment in the qualified opportunity fund on February 5, 2023 for $18,000. Remember, if the investment in the fund has been held less than 5 years the basis is zero. So, his gain would be $18,000.
Once the investment has been in the qualified opportunity fund for 5 years the taxpayer is eligible to exclude 10% of the original gain from tax. After another 2 years another 5% of the original gain escapes tax.
Example 2 – Same scenario as Example 1. Instead, Patrick sells his investment in the qualified opportunity fund on December 20th, 2026 for $18,000. After 7 years Patrick is able to use 15% of his original investment as basis. His original investment/gain was $10,000 so $1,500 would be his basis. So his total gain would be $16,500 ($18,000 less $1,500 basis).
Finally, after another 3 years, which is 10 years total, the taxpayer may sell their investment in the qualified opportunity fund and the sales proceeds are 100% tax free.
Example 3 – Same scenario as Example 1. Now, Patrick sells his investment in the qualified opportunity fund on August 5, 2028 for $18,000, meeting the 10 year holding requirement. The $18,000 sale proceeds will result in $0 tax.
As you can see keeping the investment in the qualified opportunity fund for at least 7 years but not quite 10 years only gets you a relatively small tax savings when waiting until 10 years gets you the full 100% tax savings.
It’s clear that the tax code wants the taxpayer to keep the investment in the fund for at least 10 years. This keeps investment in those distressed areas and as a carrot, gives the taxpayer an exclusion from tax when their interest in the qualified opportunity fund is sold.
The Opportunity Zone incentive hasn’t received a lot of attention. As shown in the examples above there is tremendous opportunity available to avoid capital gains tax while increasing investment in the desired Opportunity Zone areas. Contact me if you have any questions.
With passage of the Trump tax law in December 2017, states have a decision to make. The new law impacts not only the Federal side but also the Kansas side for individuals filing returns.
Many states, including Kansas, “conform” to the Internal Revenue Code (IRC). What this means, generally speaking, is the states follow the IRC with regard to what income is taxable and nontaxable, treatment of deductions, etc. The more differences there are, the more difficult and fragmented the income tax return filing process becomes. By “conforming” the states are trying to simplify the process.
One area where “conforming” is important is making the yearly choice of choosing the standard deduction or itemized deductions. This past tax season (for tax year 2018) Kansas taxpayers felt this discrepancy. The Kansas tax law states that if the taxpayer chooses the standard deduction on the Federal return, the standard deduction must be used on the Kansas return. This may not sound like a big deal until you start to analyze the numbers.
Say a married couple has $23,500 of itemized deductions on their Federal return. The new Trump tax law has bumped up the Federal married filing joint (MFJ) standard deduction to $24,000 for 2018. Clearly the taxpayer will choose the larger standard deduction. Kansas law states that because standard deduction was used on the Federal return, it must also be used on the Kansas return which is $7,500 for 2018. Here’s the kicker: in some situations, depending on which itemized deductions were included in the $23,500 itemized deduction total, the couple might have owed less overall tax if the standard deduction was used on the Federal return and itemized deductions were used on the Kansas return.
Since some Kansas taxpayers are unable to use the itemized deductions on their Kansas return because the standard deduction was used on the Federal return, Kansas has seen a surge in income tax revenue. The legislature in Topeka realized this after tax season started this spring. A bill made its way through the Kansas legislature to de-couple from the U.S. tax code but was vetoed on March 25th.
There is talk around the capital that a bill to de-couple will come up again in May. If a de-coupling bill passes with the retroactive language making it available to amend 2018 Kansas returns, all Kansas taxpayers should analyze if there is any advantage in amending their 2018 Kansas income tax returns. Under these circumstances, many taxpayers would benefit from amending their returns.
There’s no way to know what the legislature will do when the bill comes up again. If a bill is passed, taxpayers who thought they were done with taxes until next year will need to break out their trusty calculator again for the 2018 tax year.