How to Defer Taxes on Capital Gains for a Decade
- By Rick Sawyer
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- 10 Dec, 2018
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And do something meaningful with your profits
When most of us talk about the Tax Cuts and Jobs Act signed into law in December of last year, we concentrate on the benefits we derive from personal and corporate tax rate reductions. And with good reason: they favorably impact more than 90 percent of taxpayers.
But buried deep inside the bill is an opportunity for investors to defer tax on capital gains, while participating in turning around distressed neighborhoods and communities around the country.
The specific section of the law is Tax Cuts and Jobs Act §1400Z – Opportunity Zones. This new provision designates certain low-income areas throughout the country as Opportunity Zones . . . places in dire need of economic activity and job creation.
Currently, there are almost nine thousand Opportunity Zones nationwide, as well as in territories like Puerto Rico. And more can be designated in the future by state governments.
In our state of Florida, there are currently 426 Opportunity Zones, with 18 in our backyard here in Polk County.
What’s in it for you?
Let’s say you have successful investments—cryptocurrency, real estate, stocks, anything that has appreciated in value since you bought it a year or more ago. When you cash out of that investment, you’ll be subject to capital gains tax. But according to §1400Z, you can instead invest those gains within 180 days in a fund that will, in turn, invest in Opportunity Zones; these entities are referred to as Qualified Opportunity Funds by the IRS.
When you invest your profit in an Opportunity Fund, the tax on that original capital gain will be deferred for as long as you hold the new investment, or for 10-years . . . whichever one comes first.
If you hold the Opportunity Fund investment for five years, a 10 percent permanent reduction in the deferred gain will be allowed. If you hold it for two more years, an additional 5% permanent reduction in the deferred gain (15 percent total) will be allowed.
And, if you hold the investment for the full 10-year period, not only will you receive the 15 percent permanent reduction on your deferred gain, you also won’t have to pay any tax on the appreciation of your Opportunity Fund investment when you cash out.
You read that right: if the Opportunity Fund does well, you can cash out and not pay any capital gains tax on that profit.
And worst case, if the Opportunity Fund generates losses, you may be able to claim those losses.
It’s definitely a discussion every successful investor should have with his or her CPA or tax advisor.
Here are some other basics you should know:
- A Qualified Opportunity Fund is set up as either a corporation or partnership for investing in eligible property located in an Opportunity Zone
- You don’t need to live in an Opportunity Zone to invest in it
- To become certified as a Qualified Opportunity Fund, an investor/investor entity self certifies. There is no IRS approval.
- To self-certify, a taxpayer completes a form available from the IRS and attaches it to the taxpayer’s federal income tax return for the taxable year
- You make an election to defer the gain—in whole or in part—when filing the federal income tax return for the year in which the tax on the gain would be do
One area we’ve found challenging to some of our clients over the years is providing the right documentation to substantiate sizable charitable contributions.
The IRS recently published final regulations clarifying several aspects of charitable gift reporting:
Donations of cash
For contributions of $250 to $500
To claim a cash contribution of $250 to $500, you must obtain a contemporaneous (originating at the time as the gift) written acknowledgement from the recipient of the donation.
For contributions of more than $500
To claim a monetary gift of $500 or more, you need either a bank record or a written communication with the recipient showing the name of the recipient, the date of the contribution, and the amount of the contribution.
Donations of property
To claim a donation of property valued under $250, you must receive a receipt from the recipient or keep “reliable records.” (We encourage getting a receipt.)
To claim non-cash contributions valued between $250 and $500, you’re required to obtain a contemporaneous written acknowledgment.
To claim a donation valued between $500 but less than $5,000, you must obtain a contemporaneous written acknowledgment from the recipient and file Form 8283 using Section A, Donated Property of $5,000 or Less and Publicly Traded Securities.
To claim a non-cash donation valued between $5,000 and $500,000, in addition to a contemporaneous written acknowledgment, you must obtain a qualified appraisal and file Form 8283 using Section B, Donated Property Over $5,000 (Except Publicly Traded Securities).
To claim a non-cash contribution of $500,000 or more, you must meet the requirements for a contribution of $5,000 to $500,000 and attach the qualified appraisal to your return.
What’s a "qualified appraisal?"
The IRS regulations define a "qualified appraiser" as an individual with "verifiable education and experience in valuing the relevant type of property for which the appraisal is performed" (Regs. Sec. 1.170A-17(b)(1)).
We get it. Your career demands are too hectic day-to-day for you to worry about the end of your fiscal year . . . until we get to the end of your fiscal year. And since most of our clients operate as small businesses, their fiscal year usually coincides with the calendar year.
That means you’re simultaneously faced with booking and using your talent, dealing with holiday hassles, and getting your paperwork in order so your accountant can prepare your tax returns (personal and business).
Here are a few year-end tax prep tasks every client can do right now to help assure a trouble-free tax preparation and filing experience for 2018.
Get organized
CPAs generally charge by the hour. That means, if you bring us all your receipts in a shoe box, for example, your tax return will be done, but it will take us longer to sort through everything that’s in the shoe box. Just as in your business, time is money.
It’s best if all your invoices and receipts are recorded in the same format in the same software program or spreadsheet.
Get reconciled
Bank reconciliation should be ongoing on a weekly basis throughout the year, but we realize it’s one of those things that gets back-burnered in the pressure and fast-pace of your professional life.
What we’re looking for is documentation of a bank transaction that corresponds with each entry in your accounting system.
Evaluate quarterly payments
If you make estimated tax payments quarterly, check to see how they correspond to the actual end-of-year numbers you achieved. The process will give you a good idea of the amount you’ll get back or how much you’ll owe this year.
And it will give your accountant benchmarks that will come in handy while preparing your tax return.
Review your W-9s
If you hire freelancers, you must issue 1099 forms to every person you paid at least $600 to for contract labor. If you didn’t anticipate paying him or her that threshold amount, you may have overlooked having them complete a W-9 form at the time. You can still have any missing W-9s completed before the end of the calendar year.
Call your CPA today
For a successful CPA practice, every day during tax season is like Black Friday to retailers. We’re deadline driven to get every tax return prepared as accurately and efficiently as possible.
The sooner we can sit down with our clients to review appropriate records and start preparing the return, the more likely this year’s tax filing project will be smooth and stress free.
