It’s the stuff of dreams – and for some of your clients, it’s a waking reverie.
Major capital gains via selling inflated shares, a private equity investment that took off, perhaps the sale of their own clever startup to a big player – whatever the cause, they’ve cashed in. Would that it happened to all of us; some manage to make it so. Time to break out the champagne, right?
Hold off: appearing onstage is the eternal dampener of joy: the tax man. He holds an ugly bill in his hand. A juicy portion of your hard-gained earnings are set to fly from your hands – but is there still time for a rewrite?
In fact, a better path has recently been described: the Opportunity Zone. Neighborhoods suffering from long-term economic malaise can be designated as OZs, which offer important tax benefits to investors in new businesses or properties. The idea has been around for many years, but was finally brought into federal law by the Tax Cuts and Jobs Act of 2017, with broad support from both sides of the political aisle. It was that good of an idea.
Investment funds meeting the OZ regime’s requirements allow customers to place any capital gains into the fund within a six-month window of when they were netted. Taxes on these capital gains are then deferred: the bill won’t come due until the end of 2026 (payable the following April 15), or earlier if the money is withdrawn before that deadline year.
Additionally, a step-up in basis on the invested capital gains is earned: if you hold the money in an OZ fund for five years, the basis rises by 10%; after seven years in an OZ, the gain is 15%. That’s a pretty nice shave on the eventual tax bill, to say nothing about the gains from deferral.
Perhaps the best news, which will surely catch the eye of the tax-weary: if you hold an OZ fund investment for at least 10 years, any capital gains from that punt are excluded from taxation. Let’s state it clearly: if you can manage a long-term investment in an OZ, the earnings are completely tax free.
Let’s examine how this could work for clients. You have a customer who launched her career at a small tech startup firm – call it Mandarin, after the juicy fruit. A talented employee, she rose quickly and accumulated considerable stock in the firm, now a more-than-going concern.
The company’s founder, an erratic if considerable genius, led them into a cul-de-sac and was released by the shareholders. Our employee carried on loyally, expanding her company portfolio despite the vagaries in its value. One desperate day, the founder, wiser after his chastening, was called home to the company he founded. The results were astonishing and within a few years, our loyal executive was sitting on gold.
The time was nigh to cash out and retire early – with capital gains in the millions. One key question, among many: how to stymie the tax authorities? Investing in an OZ fund, with a determination to hold it for ten years or more, could be the answer. Diversification is always a concern and more liquid investments have their place, but the tax protection and growth potential of OZ investments is clear and appealing.
People selling high-valued businesses often enjoy startling capital gains, with an equally eye-watering tax bill in the offing. Opportunity Zone investments work particularly well in these cases, depending on the client’s diversification and cashflow needs.
For more information, please read:
1 Way to Completely Offset Taxes on Millions in Capital Gains | Kiplingers