The Tax Cuts and Jobs Act (TCJA) adopted in December 2017, is providing the opportunity of deferring and possibly reducing the recognition of capital gain prior to December 31, 2026.
Rules and Conditions
The new tax provision that any taxpayer that sells property which generates a capital gain, to an unrelated person can elect to defer the gain if a decision to invest in an unrelated person can elect to defer the gain if a decision to invest an equal amount into a Qualified Opportunity Fund is made within 180 days after the recognition date.
The purpose of this tax provision is to encourage investment in low-income communities. These communities have to be recognized as Qualified Opportunity Zones. If a trade or business within these zones meets certain requirements they will be a Qualified Opportunity Zone Business. The investment can be made by purchasing stock, an interest of a partnership or tangible assets and are called Qualified Opportunity Zone Property.
The new provision requires the existence of a Qualified Opportunity Fund in which capital gain can be rolled over to defer recognition. In order for a fund to be considered Qualified Opportunity Fund it has to invest 90% of its assets in a Qualified Opportunity Zone Property.
If the investment in the Qualified Opportunity Fund is sold before the 5th year anniversary of purchase date the basis will be zero. If the investments is held for 5 years the basis increases by 10% of the deferred gain. If the investment is held for 7 years then the basis will increase to 15%. And, if the investment is held for 10 years it can be elected for the basis in the investment to equal its fair market value when the investment is sold. This means that on December 31, 2026 the tax on the deferred gain will be recognized and this rule allows post-rollover appreciation to be permanently excluded.
If the investment made in a Qualified Opportunity Fund is greater than the capital gain generated by the sale of property, it is referred to as a mixed investment. The amount beyond the capital gain will be treated as a separate investment and will not qualify for the special tax provision.
The taxpayer will report the election to defer the capital gain for the year in which the sale occurred by filing Form 8949.
For the best outcome the taxpayer should consider deferring short-term capital gains first as the tax rates are higher.
Any capital gain from a sale that occurs after December 31, 2026 doesn’t benefit from this tax provision.