One of the tax planning strategies introduced by the Tax Cuts and Jobs Act of 2017 is qualified opportunity funds. By using these funds, you can defer any capital gains from the current year and then make the capital gains on your new investment tax-free. In order to do this, it’s important to understand how the rules work.
Let’s look at an example:
Suppose that, on December 1, 2018, you decided to sell $8 million of stock with an original value of $3 million. You make a $5 million long-term capital gain from that sale. Within the next 180 days, you decide to invest that capital gain in a qualified opportunity fund. On your tax return for 2018, you decide to defer the $5 million so you won’t be taxed on it that year.
On the last day of 2026, your qualified opportunity fund will have a basis of 15 percent of your deferred capital gain, or $750,000, since you held it for seven years. If your fund has a market value of $7 million at that time and you sell it, your income will be either the deferred gain or the fund’s fair market value, less the basis of the fund—whichever amount is lower. In this case, it’s the deferred gain. If you wait 10 years and sell the qualified opportunity fund at the end of 2028 for $10 million, it would have a basis of $10 million and none of your gains on the sale would be taxable.
Thus, by using the qualified opportunity fund investment strategy, you have a total gain of $10 million from these two transactions. As long as you are willing to keep that investment for at least a decade and your fund will appreciate, this can be a smart strategy for you.
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