By Len Green & John Wollenberg
There is an exciting new Tax Law that could:
1. Defer the paying of taxes.
2. Reduce your taxes.
3. Provide a new and exciting way to invest your previous sales proceeds and eventually, if the new investment is profitable, sell the new investment and not pay taxes on the gain.
Let’s get into the details.
If you sell horses or other farm property at a profit and these gains are considered capital gain assets, did you know that you can:
1. Defer paying the tax on the capital gain for 10 years
2. Reduce the taxable gain amount by 15% as well
3. Exclude gains from reinvested proceeds
The recently enacted Tax Cut and Jobs Act has introduced these three tax election benefits for investments in Qualified Opportunity Zones.
Description of Opportunity Zone
First, an Opportunity Zone (“OZ”) is a government-designated community where new investments may be eligible for this new preferential tax treatment. In other words, Opportunity Zones are a social policy tool designed to spur economic development and job creation in distressed communities by providing tax benefits to investors.
The current list of approved Opportunity Zones can be found at Opportunity Zones Resources and in the Federal Register at IRB Notice 2018-48.
An investor does not need to live in an OZ to take advantage of the tax benefits described below. The tax benefits are available even if the investor does not live, work or have a business in an OZ. All the investor needs to do is invest in a Qualified Opportunity Fund (“QOF”).
What is a Qualified Opportunity Fund
A QOF is an investment vehicle that is set up as either a partnership (including a limited liability company) or corporation for investing in eligible property that is in an OZ and that utilizes the investor’s gains from a prior investment for funding the QOF. The Fund cannot invest in another QOF and must hold at least 90% of its assets in Qualified Opportunity Zone property.
1. Qualified Opportunity Zone Stock
2. Qualified Opportunity Zone Partnership Interests
3. Qualified Opportunity Zone Business Property
Qualifying property includes an investment in an “OZ Business.” An “OZ Business” needs to have “substantially all” of its tangible assets to consist of Qualifying Opportunity Zone property. Recently issued proposed regulations provide that if at least 70% of the tangible business property owned or leased by a trade or business is Qualified Opportunity Zone business property, the “substantially all” threshold will be satisfied.
The qualifying property needs to be either:
1. Tangible property acquired after December 31, 2017 used in the Fund’s trade or business where the original use of the property is in the Fund.
2. The Fund substantially improves the property within 30 months and the improvement additions exceed the original cost basis.
Under the proposed regulations, if the tangible property is a building or barn, then “substantial improvement” is measured only by the building’s basis, not including the cost of the land.
The 90% requirement will be tested by the average of the amount invested in the property on:
1. The last day of the six-month period of the Fund’s tax year
2. On the last day of the Fund’s tax year
What are the Tax Election Benefits
The first election defers capital gains that are reinvested in a QOF.
The second election reduces gains up to 15%.
The third permanently excludes gains from the sale or exchange of the investment in the Fund.
First Election Benefit (Deferral to Year 2026)
When you sell stock or other capital gain property for a gain and within the next 180 days you invest the gain in a QOF, you can elect to defer the gain.
There are no restrictions on the type of eligible property, only that the gain arises from a sale or exchange to an unrelated person. Real estate, personal property, intangible assets, vehicles and essentially any other asset qualifies.
Basically, this new Law applies to many of the assets we utilize in our Thoroughbred activities.
By comparison, under the new Tax Rules for like-kind exchanges, IRS §1031 treatment is now available only for real estate. Also, only the amount of the gain needs to be reinvested. With a like-kind exchange, an amount equal to the proceeds needs to be reinvested to achieve a full deferral.
Under this first election, you can defer the gain until the later of the date on which the investment is sold or exchanged, or December 31, 2026. So, to get maximum benefits, the developer you select should have the intention of this being a long-term project.
Second Election Benefit (Up to 15% Reduction in Taxable Gain)
In addition to the deferral feature, a step-up in basis is available for capital gains reinvested in an Opportunity Zone Fund. Your basis is increased by 10% of the gain after five years, and by another 5% of the gain if held for seven years, thereby excluding up to 15% of the original gain from taxation. In order to get the full 15% step-up, you need to reinvest by December 31, 2019.
There is no dollar limitation on the amount of the gain that can be deferred.
Third Election Benefit (Permanent Exclusion)
As a further sweetener, you can permanently exclude any post-acquisition capital gains on an investment in an Opportunity Zone Fund if the investment in the Fund has been held for ten years.
As an example, suppose you realize a $1 million capital gain in 2019 from the sale of a horse or other farm property. You then elect to reinvest the $1 million gain amount in a QOF by December 31, 2019 and you will keep that investment for ten years. The result is you will be able to defer the tax due on the original $1 million gain until tax year 2026. In addition, since the Fund investment will be held for more than seven years, the basis is stepped up by 15%, so that the taxable gain in 2026 is reduced to only $850,000, thereby sheltering $150,000 on the original gain. Finally, if you hold the Opportunity Zone Fund investment for at least ten years, no capital gains tax is owed on the appreciation of the investment from within the Fund.
Investing in a Qualified Opportunity Fund
The proposed regulations clarify that an investment must be an equity interest, including preferred stock or a partnership interest with special allocations. Debt does not qualify. An investor can borrow money to make the investment, even using the interest as collateral.
In order to become a Qualified Opportunity Zone Fund, an eligible taxpayer will be allowed to self-certify. No approval is needed from the IRS. To self-certify, a taxpayer only needs to complete Form 8996, which will then be attached to the taxpayer’s income tax return, both for the initial year, as well as for all relevant subsequent years. The QOF will complete Form 8996 not only to self-certify but also to annually report compliance with the 90% asset test.
For the past 35 years, The Green Group has been catering to specialized tax savings plans for both the equine and real estate industry. If you have any questions on how to take advantage of such plans, please feel free to call The Green Group and speak with one of our trusted advisors. We look forward to saving you money and growing your business!