Part of living in a small-town is the drive to boost the local economy, by investing in it. The 2017 Tax Reform and Jobs Act encourages business owners and entrepreneurs to do just that, through its creation of Opportunity Zones throughout the nation. Fortunately, California has a number of these designated Qualified Opportunity Zones (QOZ’s) in the Sacramento Valley of which investors can take advantage.
Here’s how it works:
- The State of California has designated certain distressed areas in the state as QOZ’s
- If an investor realizes a gain on the sale of a capital investment, he invests the gain in a QOF, which holds properties located in QOZ’s. In return, the investor receives stock in the fund. There is no monetary limit on the size of the QOF, so long as 90% of the fund’s assets are actual qualified properties.
- Proceeds from these funds can be used to improve the distressed properties in the funds.
- The incentives for investing in a QOF vary, depending on how long a property stays in the fund, as shown in the graphic below:
Length Investment stays in QOF
|<5 years||Payment of existing capital gains taxes is deferred until investment is sold|
|5 – 7 years||Deferred capital gains tax (same as above), but now only 90% of the tax is owed|
|7 – 10 years||Payment of existing capital gains taxes is deferred until investment is sold, or until December 31, 2026, whichever comes first, but now only 85% of the tax is owed|
|>10 years||Same benefit as above, plus no additional capital gains taxes are owed for the life of the investment.|
What does this mean? Let’s look at an example:
In 2014, Adam buys 1,000 shares of stock in NVIDIA, at $150/share, for a total cost of $150,000. In 2018, Adam now sells these shares at $250/share, for a total sale price of $250,000. Adam has now made a gain of $100,000. Adam puts this $100,000 into a Qualified Opportunity Fund and holds it there until 2028. This fund purchases preferred stock in companies located in Qualified Opportunity Zones. Here are the advantages to investing in a QOF, as opposed to using the gain for other investments:
- Immediately, Adam can invest the entire $100,000, instead of the $76,200 he’d have left over if he had to pay capital gains taxes right away. This gives him an additional $23,800 to use to purchase shares in the fund, which results in larger stock purchases, larger dividends payouts, and larger gains in general.
- In 2026, when Adam has to pay the capital gains tax, he now owes $20,230 instead of $23,800 – that’s $3,570 in taxes that he no longer has to pay!
- In 2028, when the fund is dissolved, Adam owes no additional capital gains taxes on the gains made between 2026 and 2028
The good news for local investors is that large portions of Yuba and Sutter counties (see picture) have been designated as Qualified Opportunity Zones, along with areas in Colusa, Butte, Nevada, and Sacramento counties. This creates a prime market with good investment advantages throughout the northern portion of the Sacramento Valley, which can help boost the local economy.
This also gives business owners an incentive to establish businesses in the designated areas, because of the investors drawn to these locations.
With the introduction of this program, we expect to see more investors look to the Yuba-Sutter area. This is good for commercial property owners as more businesses are driven to the area. If you’re looking to add commercial real estate to your portfolio, now is the time to do so, while the tax reform is relatively new and before many people have taken advantage of it.