Opportunity Zones
A Tax-Efficient Investment Strategy for 2024 and Beyond
The robust stock market performance in 2024 has created significant opportunities for realizing capital gains. As we approach year-end and early 2025, financial advisors seeking tax-efficient strategies for managing gains should consider Opportunity Zone (OZ) funds as a compelling solution. Despite common misconceptions, the “opportunity” in Opportunity Zones has not passed; the legislation remains active, and its core benefits are as impactful as ever.
Key Tax Benefits of Opportunity Zone Investments
- Deferral of Capital Gains Tax: By reinvesting capital gains into a qualified OZ fund, investors can defer the payment of capital gains taxes until the earlier of the fund’s sale or December 31, 2026.
- Permanent Exclusion of New Gains: Gains generated within the OZ fund are exempt from federal taxes (and possibly state taxes) after a minimum holding period of ten years.
- State Tax Considerations: Some states offer additional tax benefits, further enhancing the after-tax return potential. Understanding state-specific OZ regulations is crucial for maximizing the strategy’s effectiveness.
It’s a common misconception that the Opportunity Zone tax incentives have expired. While the step-up in basis that Opportunity Zone investing originally offered has phased out, this benefit was marginal compared to the primary driver of return for Opportunity investing: the exclusion of new gains from taxation.
Since the legislation’s inception, this tax benefit and the forgiveness of depreciation recapture upon the sale of the OZ investment have been the primary drivers of tax-enhanced returns.
Let’s walk through a hypothetical illustration: Assume your client bought stock in late 2023 with a $500,000 basis, and the stock performed incredibly well, and less than a year later, the market value of that stock is $1.5 million. With recent volatility, the client is nervous about the concentrated position and is looking to lock in the gain. On the other hand, your client is in a high tax bracket and generally averse to the idea of paying taxes. An opportunity zone investment would be worth consideration.
The client would realize a capital gain of $1,000,000 by selling the stock. For this scenario, we’ll assume the investor reinvests the entire gain into an Opportunity Zone fund within 180 days (the applicable deadline for deferral of a gain into an OZ fund). Let’s compare an OZ investment to a non-oz investment:
As the illustration above shows, with all other assumptions being equal, the client’s investment in the opportunity zone could result in an extra $600,000+ of return depending on the client’s tax bracket and state of residence. This simplified scenario highlights the impact of the OZ program on long-term returns, showcasing its ability to preserve and grow wealth for the right investors.
As capital markets continue to offer robust opportunities for realizing gains, Opportunity Zone Investing should be a tool we understand and deploy where it’s a good fit. While the recent election results may foreshadow an extension of the opportunity zone program beyond 2026, investors can take advantage of this strategy in its current form through 2026. W Financial advisors, tax professionals, and Opportunity Zone fund managers can help identify suitable investments aligned with tax and portfolio objectives.
Conclusion:
The Opportunity Zone program remains a potentially transformative investment vehicle for those seeking to balance immediate tax deferral with long-term tax-advantaged growth. While ancillary benefits may have sunset, the core incentives provide advantages for investors harvesting gains in 2024 and beyond. By leveraging this powerful tool, investors can turn today’s market opportunities into lasting financial rewards while contributing to the economic revitalization of underserved communities.
If you want to learn more about Opportunity Zones and how they may be applied in your client’s portfolios, Redbrick LMD offers in-person and online training that qualifies for one hour of CFP® Continuing education credit. Please contact us at [email protected] to learn more.
This example is a general illustration of the estimated tax benefits of investing in an Opportunity Zone Fund and is not a projection of the returns or tax benefits of any specific Opportunity Zone Fund. This example makes several simplifying assumptions, including the assumption that the investment does not make distributions before the disposition of the underlying asset. If an Opportunity Zone Fund makes interim distributions, such amounts may be subject to current tax, which would reduce after-tax returns. The performance shown is not indicative of any actual results. Tax scenarios presented are subject to change.
The chart above assumes a capital gain of $1,000,000, an investment date of 2024, and an investment hold period of 10 years. It assumes a federal capital gains tax rate of 20%, net investment income tax (Medicare tax) of 3.8%, and representative state tax rate of 6.2%. The actual tax rate will depend on the individual taxpayer’s particular situation. Assumes a hypothetical net IRR (after accounting for fees and expenses) of 13.0% for both the taxable investment and the Opportunity Zone Fund Investment.
This example relies on current tax law, which is subject to change. The numbers and calculations included on this page are for illustration purposes only. Investors should consult their own tax advisors and not rely on these materials for tax advice. The illustration is hypothetical and assumes that the future value of the initial investment does not and has not fallen below its initial basis and that the investment can be sold at a gain, but there is no guarantee that this will happen.