Our income tax system makes tax planning difficult for those years you expect to recognize unusually high amounts of income in a single tax year. Whether you are selling a business, real estate of even stocks with high amounts of gain, large injections of taxable income can push you up into the highest tax brackets, causing you to pay twice as much as you would have paid if you could spread the tax out.

If you follow us or have worked with us than you know, more often than not, we will accelerate the tax you pay so we can create a tax-free future. Roth conversion strategies are a good example of this. In some cases tax planning requires us to take the opposite approach, like when someone sells a business or a highly appreciated piece of real estate. In these cases it can be difficult to find ways to defer taxes, but the new tax law has offered us a new option called Opportunity Zones. 

Investing in Opportunity Zones

Investors who reinvest capital gains money in Opportunity Zone funds will receive reductions on capital gains taxes relative to the years of their investment. Not only will you receive tax deferral on the gains you reinvest, but you will also receive a discount on those gains if you hold the new investment long enough.

The following is from https://www.azcommerce.com/arizona-opportunity-zones/

Investments held 10 years: taxable amount of the capital gains reinvested is reduced by 15% and no tax is owed on appreciation. For example: $100 of capital gains is reinvested into an Opportunity Zone fund and held for 10 years. Tax owed on the original $100 is deferred until 2026, and taxable amount is reduced to $85 ($100 minus $15). Investor will owe $20 of tax on the original capital gains (23.8% of $85). No tax is owed on Opportunity Zone investment’s capital gain. Assuming a 7% annual growth rate, the after-tax value of the original $100 investment is $176 by 2028.

Investments held 7 years: taxable amount of the capital gains reinvested is reduced by 15%. For example: $100 of capital gains is reinvested into an Opportunity Zone fund and held for 7 years, selling in 2025. Taxable amount is reduced to $85 ($100 minus $15). Investor will owe $20 of tax on the original capital gains (23.8% of $85). Assuming a 7% annual growth rate, the investor will owe $15 in tax (23.8% of $61) on the Opportunity Zone investment’s capital gain.

Investments held 5 years: taxable amount of the capital gains reinvested is reduced by 10%. For example: $100 of capital gains is reinvested into an Opportunity Zone fund and held for 5 years, selling in 2023. Taxable amount is reduced to $90 ($100 minus $10). Investor will owe $21 in tax on the original capital gains (23.8% of $90). Assuming a 7% annual growth rate, the investor will owe $10 in tax (23.8% of $40) on the Opportunity Zone investment’s capital gain.

My favorite piece of this new strategy is that you can cherry-pick the gain you reinvest from a transaction. If you sell a home for $1,500,000 and your cost was $1,000,000, you can keep $1,000,000 without paying tax and reinvest the remaining $500,000 in gain with an Opportunity Fund, deferring the tax and receiving a potential discount on that tax down the road. 

These strategies are in a stage of infancy but they present new and unique opportunities to compliment your advanced plan. If you would like more information on tax planning using this strategy, contact us at 480-818-8300.