With this year's strong stock and property markets, figuring out how to minimize capital gains tax may be top of mind for investors.
Qualified opportunity funds can provide tax advantages, but acting fast makes a difference: You can reap the benefits of three tax perks instead of just two if you invest by year-end.
What is a qualified opportunity fund?
In 2017, the Tax Cuts and Jobs Act established a new tax perk allowing investors to defer and minimize capital gains taxes when reinvesting capital gains into qualified opportunity zones, which are economically depressed regions within the U.S.
Qualified opportunity funds invest in businesses or properties within qualified opportunity zones, offering that preferential tax treatment to the fund investors.
By encouraging investment into opportunity zones, the government hopes to propel economic growth by creating more jobs, driving business activity, expanding housing options and kickstarting new startups in distressed communities.
Whether that plan will work is up for debate: A June 2020 study by the Urban Institute found that though there have been investments that made community impact, oftentimes the capital has not gone toward the areas with the greatest need, but rather has benefited real estate developers more.
Why invest in qualified opportunity funds?
Say you've sold an asset (real estate, investments, a business, etc.) and have a large capital gains tax liability on your hands. Or you'd like to offload an investment, but the capital gains tax consequences have kept you from doing so. By rolling those capital gains into a qualified opportunity fund, you can defer and reduce your capital gains tax liability, diversify your portfolio and make a positive impact.
As with any tax break, many rules apply. You must reinvest your eligible gains into a qualified opportunity fund within 180 days from when the gain would be recognized to qualify for these tax advantages. And, not all gains are eligible: Only capital gains or qualified 1231 gains (gains on certain types of business properties) recognized for federal income tax purposes prior to Jan. 1, 2027, will count.
In order to make sure you're following the rules, considering all potential implications and filing the appropriate paperwork, consult with tax or financial advisers well-versed in qualified opportunity funds to help smooth the investment process.
Investors who are interested in qualified opportunity funds start out by talking with their accountant.
Tiffany Lam-Balfour writes for NerdWallet.com.
