by Bryan Perry

September 1, 2020

For some investors looking to lighten up or rebalance their portfolios into the teeth of this torrid rally, there is a special tax shelter that offers some pretty attractive benefits that are quite unique.

While most of us have heard of Opportunity Zones, I imagine that most folks don’t quite know how they work or how they might fit into one’s portfolio. Inspired by entrepreneur and philanthropist Sean Parker (co-founder of Napster), his foundation set out to help shape public policy for the greater good in places where he thought the government simply fell short due to the usual bureaucratic and political red tape that constantly thwarts real societal progress.

Here’s how Parker describes the challenge and opportunity in The Parker Foundation’s opening page:

The Great Recession of 2008-2009 was the sharpest downturn in economic activity since the Great Depression. While many parts of the country have since recovered, the gap between the richest and poorest American communities has widened since the Great Recession ended. America is suffering from deepening geographic inequality linked to economic inequality – distressed areas are faring worse as the most prosperous areas have enjoyed tremendous growth. As gains continue to consolidate in the largest and most dynamic counties, other areas are left behind, searching for their place in the new economy. We must find a new toolkit for ensuring broad access to opportunity and helping both people and places realize their economic potential.

Opportunity Zones were first proposed in a bi-partisan bill by Senators Tim Scott (R), Cory Booker (D), and Rep. Ron Kind (D) and supported by Sean Parker’s Economic Innovation Group. These Opportunity Zones were then created under the Tax Cuts and Jobs Act of 2017 and signed into law by President Trump on December 22, 2017. Opportunity Zones are lower income census tracts nominated by state governors and certified by the U.S. Department of the Treasury. The United States has over 8,700 designated Opportunity Zone census tracts throughout the country, in every state and U.S. territory.

Local Initiatives Support Corporation Breakdown Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The primary focus of the Opportunity Zone program is to stimulate economic development and job creation by incentivizing long-term investment in low-income communities. This is a prime example of the public-private partnership arrangement, which I wrote about last week, in which private capital can partner with federal and state governments to rebuild distressed communities and help them prosper.

The Opportunity Zone program enables investors to reinvest capital gains into Qualified Opportunity Funds (QOFs), which put capital to work by financing construction projects in low-income communities and, in exchange, investors receive certain federal (and possibly state) capital gains tax advantages.

Many investors have accumulated capital gains from savvy purchases of stocks with an extremely low cost basis, making disposition of such assets a severe taxable event. (We run into this dilemma all the time within the Navellier Private Client Group.) Here’s a chance to offset some of those gains via Qualified Opportunity Zone Fund investing. Clients who re-invest their qualifying capital gains into a QOF within 180 days of recognition of that capital gain are eligible for the following tax benefits:

  • Deferral of Capital Gains Taxes:Capital gains taxes will be deferred until the earlier of the end of 2026, an inclusion event, or the date on which an investor sells its QOF investment. Capital gains eligible for deferral through reinvestment in a QOF include both short- and long-term capital gains resulting from the sale of a wide array of asset classes, including, without limitation: stocks, bonds, commodities, certain cryptocurrencies, artwork, automobiles, jewelry, and real estate.
  • Reduction of Deferred Capital Gains Taxes:Investors will receive a 10% step-up in the basis of any capital gains that are reinvested in QOFs, if the QOF investment is held for at least five years.
  • Complete Elimination of Capital Gains Taxes:QOF investors are exempt from federal taxation on capital gains derived from the appreciation of their QOF investment, if the QOF investment is held for at least 10 years.
  • Possible State Income Tax Benefits:Depending on the state where the investor is domiciled and whether that state conforms with federal Opportunity Zone regulations, an investor may be entitled to receive the same federal Opportunity Zone capital gains tax benefits (deferral, reduction, and elimination of taxes) on a state income tax level (source: irs.gov).

Qualified Opportunity Fund Timeline Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

For investors who are still working and earning large incomes now, and who plan to retire by 2026 and move into a much lower tax bracket – this is a highly attractive proposition for them to consider. The current basic capital gains rates are 0%, 15%, and 20%, depending on one’s taxable income. A savings of 5% on a capital gain of $500,000 translates to real money in retirement.

No matter if one’s capital gains are derived from short-term or long-term investments, those gains, if invested within 180 days of the sale of the asset and into a Qualified Opportunity Fund (QOF)the tax payments for those capital gains are deferred until 2026 and all the capital appreciation achieved from the properties within the Opportunity Zone Fund are free of taxation, similar to how a Roth IRA functions.

According to www.opportunitydb.com, there are 247 Opportunity Zone Funds with a total investment capacity of $56 billion as of July 1, 2020. The projects within these funds can include affordable multi-family residential housing, student housing, workforce housing, renewable energy, hospitality, retail, manufacturing, industrial, medical, warehouse properties, and mixed use.

The 247 Opportunity Zone Funds available are all private funds, with the exception of Belpointe REIT (BELP) – the only listed QOF. I have no position in BELP, but it’s always nice to have the option of exiting an asset with the click of a mouse. Private funds typically have restrictive redemption features, like surrender fees or specific exit periods, or they can be subject to discounted gray-market bids for units. So, consult with your tax advisor before considering such a tax-sheltered investment.

By and large, Opportunity Zone Funds are a sound approach where those investors fortunate enough to score big profits from the bull market can invest those capital gains into thousands of America’s struggling areas and help build a future for those seeking a better way of life without having to leave their community. This is how capitalism, in my opinion, can work wonders in tandem with good government public policy for the benevolence of others, if executed properly and with good intent.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Bryan Perry

Bryan Perry
SENIOR DIRECTOR

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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