How to Protect Your Capital Gains with Opportunity Zone Investments

If you sold your property within the last 180 days, you can reinvest that capital gain and defer and reduce the tax you’ll have to pay at filing time. If the income results from the sale of assets in a partnership filing K-1, the 180 days runs from the end of the calendar year.

In this article, we’ll give you a concise overview of what opportunity zones are, how to get started investing, and why and how you might want to create your own qualified opportunity zone investment fund (QOF).

What Are Opportunity Zones? How Do They Protect My Capital Gains?

If you’ve recently realized capital gains (made a profit) from the sale or transfer of personal or partnership assets and you’re facing the payment of a large tax liability to the IRS – current capital gains taxes range as high as 20% depending on your income– opportunity zones allow you to put off or defer paying taxes as long as the investment is held in the QOF.

The Tax Cuts and Jobs Act of 2017 (TCJA) created the opportunity zone program to provide a financial incentive to investors for allocating capital to economically disadvantaged communities. The Act created more than 8700 designated qualified opportunity zones (QOZs)

What exactly are the benefits of investing in opportunity zones?

  • You can earn strong returns and pay no more than the original deferred tax (reduced by incremental step-ups in basis).
  • 10% step-up in basis after 5 years. Pay tax on only 90% of original gain.
  • 15% step-up in basis after 7 years. Pay tax on only 85% of original gain.
  • Complete elimination of tax on post-investment capital gains after 10 years.
  • Pay tax on only 85% of original gain if held more than ten years. No tax on subsequent gain.
  • You can invest in business or real estate assets.

Investing in opportunity zones allows you to protect your retirement and heir’s inheritance from excessive taxation by the federal government.

If you’re willing to commit to a 10-year investment, you can reduce your tax basis by 15%, and pay no capital gains tax on any new gain.

How Do I Get Started Investing in Opportunity Zones?

The first consideration is finding a QOF. Per the TCJA, QOZ investments must be made through a QOF.

There are two ways to approach this: you can either invest with an existing QOF or create your own by self-certifying with the IRS using form 8996.

Working with an existing QOF is a good choice if you’re looking for professionally-managed investments that won’t require you to be personally involved in property or asset management.

If you want more control over your money and investments, it’s not too difficult to self-certify as a QOF.

Now, the list of qualifications/requirements is a bit intimidating, but here’s a brief summary­–consult an investment advisor and accountant:

  • 90% of the funds assets must be held in opportunity zones.
  • Eligible entities include corporations, partnerships, and LLCs (those treated as a partnership or corp for tax purposes).
  • Self-certify with form 8996. No application or approval requirement.
  • QOF assets must be placed into service in a QOZ for the first time by the QOF, or
  • Be ‘substantially’ improved within 30 months.

Tips For Aspiring and Professional Opportunity Zone Investors

If you have capital gains to reinvest and the tax benefits are something that fit your financial and tax needs, you’ll need to proceed with caution before making a pledge.

Take care in researching, interviewing, and reviewing the offering memorandums of the QOFs you consider. Select a fund that specializes in the types of assets in which you’re most interested and that has a track record in QOZ investments or business and real estate development.

Creating your own QOF sound most appealing? Do your homework, evaluate your relevant experience, skills, and enlist the counsel and aid of real estate, legal, finance and other associated professionals to lend capability and credibility to your team.

Finally, inclusion in an opportunity zone doesn’t mean a great investment. Evaluate the market based on population growth, rental rate trends, quality educational institutions, strength of industry, zoning policy, and numerous other economic, regulatory, and social considerations.

Once you find a property or investment, conduct the same due diligence in assessing its condition, cash flow, and functional utility (livability and usefulness for modern buyers). Depending on the QOF, you can invest in an individual property or portfolio of units.

Time is of the Essence

Take action now to research your options if you need capital gains tax relief. You have a limited period from when gains are realized until they must be contributed to qualify for the tax-deferral benefits.

Depending on your background and how involved you want to be in the investment, you can either invest in an existing QOF or start your own and self-certify with the IRS.

Whichever path you choose, do your due diligence and select an investment based on the factors that you would consider for any traditional opportunity. When you choose a QOZ investment in a market with strong rental demand, favorable local policy, and economic growth, you’ll have a stable-return asset that shelters your existing and long-term gain.

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Should I Sell My House or Turn It into a Rental Property?

Sometimes, a homeowner can choose whether to sell a single-family residence or keep it for rental income. This option often presents itself to an owner who has saved enough cash to use as a down payment for a new primary residence. Also, this decision-making predicament is typical of someone who has inherited a house, has purchased a building for a child’s college years, or is relocating temporarily. Every one of these choices is viable under different circumstances; a homeowner who considers all the associating factors of each option will more likely reach the best conclusion.

Legal and Financial Considerations: Your Key to Navigating the Slippery Road of Rental or Occupancy

Local zoning laws and covenants occasionally prohibit rental of single-family residences. Check the local zoning authority and homeowners’ association to confirm that your rental is permitted. Mortgages on single-family residences often require the borrower to be the principal resident of a home. This will require an owner to have either paid off existing loans or work with the lender to modify the terms of those loans.

Using a house as a rental property is a form of investment. A wise investor compares a house rental with other investments to determine whether rental generates the greatest return. Return on investment usually includes both net cash flow and change in equity: a house’s resale value determines equity change. So, an investor also needs to research the housing market to know if their house is likely to increase in value over time.

Investors also consider the tax implications of renting out a house. Normal expenses—such as repair, maintenance, real estate taxes, and leasing costs—can be deducted from rents, resulting in a lower taxable income. The costs of acquiring and improving a house can be also be subtracted from taxable income by using a depreciation process. But a homeowner’s standard exemption from capital gains taxes is not allowed for rental property.

Practical and Management Factors

Renting out a house is an active (rather than passive) investment. That means the owner must deal with leasing, management, and maintenance concerns. The owner will not only have the time and ability to take care of these issues, but they must also set aside some money for scheduled maintenance or unexpected emergencies.

The landlord role can be daunting and aggravating; if a house owner instead opts to pay for professional management, that cost will substantially reduce net income flow. Risk for a rental house investment can also be relatively high. Tenants may damage the property, leave without paying rent, or require eviction. Liability insurance can offset some of these risks as well as relieve the owner of any responsibility should a tenant be injured in the rental house.

A Third Option: Providing Seller Financing

An alternative way of generating cash flow while avoiding the complications of rental is to sell a house and provide the financing for part or all of the sale price. Again, if there is still a mortgage on the house, the original loan may not allow owner financing. Even when owner financing is permitted, the original loan is primary, meaning the lender has first right to repayment; the owner-lender becomes secondary or junior. Therefore, if a buyer defaults, the first owner is still responsible for mortgage payments, and the house still is collateral for the original loan. Besides that, providing owner financing does carry some tax benefits. Income tax applies only to the interest portion of loan payments and capital gains taxes are spread over the life of the loan.

There are certain financial insecurities associated with providing owner financing. The buyer-borrower could default on the loan. Most borrowers do not remain in homes for the regular financing periods of 20 to 30 years, suggesting that the original owner will require a balloon payment upon resale. Professional legal and accounting services are necessary for the owner-lender to ensure safety and maximum investment returns.

Research, Then Decide: Equip Yourself with Market Information before Investing

A variety of factors will influence a home owner’s decision to sell or rent out their house. Rental must be permitted under local zoning laws and covenant restrictions. The existing loan on a primary residence will likely prohibit rental use. Rental might be dependent on free and straightforward ownership or available commercial financing. Once in a while, other investments out-perform rental houses: a homeowner should thoroughly investigate the rental market, probable expenses, and potential rental income, and compare the net income to competing investments. Part of the total investment income will be the eventual resale proceeds from a house. In a stagnant or declining market, those proceeds may be minimal. Managing rental property requires time, resources, and resilience. A possible alternative is selling the property with owner financing to generate an income stream with much less active owner involvement, yet with tax benefits.

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Selling an Inherited Home Without the Stress

Inheriting a home and not sure what to do? Do you keep it, sell it? It’s a tough decision that can often be an emotional one as we deal with the loss of our loved one.

If you’re still going through the probate process, or other issues involved with transferring an inherited property, then you know the stress associated with dealing with attorneys, court officials, real estate agents, and buyers.

Keeping It or Selling It

If it’s the home you grew up in and there’s a lot of memories that you’re not willing to let go of, you may decide to keep the property. If you do, what are your options?

You can choose to move in and occupy yourself, or you can rent it out for a sufficient amount to cover any existing mortgages, insurance expense, property taxes and maintenance expenses. Renting is great if you don’t mind the management duties or additional liability of rental property ownership.

Selling can also be beneficial as it will allow you to quickly move on with other aspects of your life. The additional funds can be used to pay off another mortgage, renovate, travel, or fund the education of a child or grandchild.

Tax Concerns

Fortunately, there are some good tax strategies that can help you avoid paying excessive taxes if you decide to resell your inherited property. If you decide to keep it for the short term, you can move in and occupy the property for two years to earn the capital gains tax exemption for primary residences. The exemption allows homeowners to reduce the taxable amount of the sale by $250k for individuals and $500k for married couples.

Even if you decide not to make the property your primary residence, you still have some protection from taxes thanks to the IRS’s stepped-up tax basis rules for inherited properties. When you choose to sell the property, your tax basis will be the market value at the time of the prior owner’s death. For example, if you decide to sell the house in two years for $320,000, and the property was appraised at $300,000 when you inherited it, you’ll only have to pay taxes on the difference of $20k.

Choosing to Sell

If you’re ready to sell, and you’re not looking forward to putting the property on the market, dealing with nosy buyers, or dealing with any of the stress and hardship surrounding selling the property, there are some very effective strategies to get it sold quickly and allow you to move on with your life. We can make you a cash offer with very few contingencies that will be fair and practical and make the decision to sell easy and stress free. Unlike the conventional selling approach with an agent, we pay all the closing costs so you pay nothing out of pocket.

As many homes that are inherited tend to have, there may be repair and modernization issues that need to be addressed. When you accept an offer from us, you don’t have to make any repairs, deal with any cleaning, or worry about functional and cosmetic upgrades. We’ve designed our closing process to make it as convenient and inexpensive as possible to sell your home. Please reach out to us today by phone, email or text to find out home much you could receive for your property, or click here to request an offer online.

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