Stocks, real estate and alternative assets are near their all-time highs amid an election year with an uncertain tax landscape looming. Investors are calling and seeking last-minute tax mitigation strategies. For clients who have big gains from appreciated assets, I often recommend the federal Opportunity Zone program because it's the most flexible and most impactful tax deferral program I've seen in my 40-plus-year career.
As of now, the OZ program is set to begin winding down in 2026. Absent
In a nutshell, the OZ program allows investors to defer their capital gains from sales of appreciated real estate, stocks, businesses, personal residences, collectibles and even crypto through 2026. They do so by investing in one of 8,700 distressed areas of the United States via a qualified opportunity fund. They just need to make their investment within 180 days of the gain reporting date. If the gain is coming through a K-1, the start of the 180-day period can be delayed until March 15 of the year following the gain date. The QOF then deploys those gains into qualifying real estate or an operating business located within one of the 8,700 designated OZ census tracts.
By keeping their invested gains in place, your clients won't pay tax on those gains until at least April of 2027. Further, if they hold the investment for 10 years, all post-reinvestment appreciation from their original QOF investment will be excluded at the federal level — and at the state level in all but six states.
Bipartisan support
The OZ program has always had bipartisan support because it's designed to spur economic growth in underserved areas. QOFs have raised an estimated $150 billion in equity since the program began in 2018 — far surpassing the most optimistic projections. Further, bipartisan legislation is pending to push out the gain deferral period from 2026 to Dec. 31, 2028. Proposed legislation would also bring back the basis step-ups of 10% and 5% that were part of the original program, but with shorter holding periods to qualify for the step-up — five years for the 5% step up and six years for the 10% step up.
Advantages of doing business in an opportunity zone
People typically associate OZ funds with real estate development, but about 25% of our OZ work involves operating businesses located within Opportunity Zone census tracts throughout the U.S. For your clients that are startups or existing businesses, there are many advantages to relocating to Opportunity Zones, such as more affordable real estate, rental rates and operating costs to help businesses save money.
To become a qualified Opportunity Zone business, a business must meet the 50% gross income test. There are three "safe harbors" within the regulations and the business must meet only one of them:
- At least 50% of the services performed (based on hours) by its employees or contractors are performed within the qualified Opportunity Zone.
- At least 50% of the compensation paid to QOZ-based employees and independent contractors is performed in the QOZ.
- The core operations and facilities responsible for generating half of the business' gross revenue are located within a QOZ.
Our firm works with many serial entrepreneurs, including tech gurus and engineers, who sell their family businesses, rental real estate or personal real estate, and then roll the gains into a QOF where they start one or multiple businesses within the QOZ. Many entrepreneurs are using a combination of real estate entities and operating businesses in their OZ Funds.
OZ for homeowners with big gains
In today's real estate market, many homeowners are joyfully selling their residences for substantially more than they paid for their properties years or even decades ago. But after closing, they're surprised to receive hefty capital gains tax bills on the appreciation over their first $500,000 in basis (married) or first $250,000 in basis (single). For instance, a married couple that bought their house for $200,000 30 years ago and sells it for $1 million today would have an $800,000 gain and would have to pay capital gains tax on $300,000, after claiming the $500,000 primary residence exemption ($1 million - $200,000 - $500,000). That's a federal tax bill alone of $45,000 to $60,000.
If the homeowners are in good health, then reinvesting the capital gain into a QOF can offer substantial tax savings. In the above example, they still have $700,000 in cash after making the QOF investment, assuming there was no mortgage.
OZ vs. 1031 exchange
The OZ program differs from a 1031 exchange in several ways. A 1031 exchange can only be used for real estate assets, whereas with the OZ program, the gain from the sale of any type of asset — real estate, stocks, bonds, collectibles, crypto, etc. — can be placed into a QOF and receive the tax benefits. Remember, the OZ program only requires your client's gain to be placed into the QOF (not the full market value of the investment) to defer 100% of the gain. Then the QOF or a subsidiary QOZB invests in the property. Your client cannot invest in the property directly.
Example: Let's say you had $300,000 basis on a piece of land, and you sold it for $1 million (i.e., a $700,000 gain). To get the full deferral under a 1031, you'd generally have to buy a $1 million dollar piece of property. In the OZ world, you would only have to reinvest $700,000 to eliminate 100% of your gain.
Also, under the OZ program, all the depreciation you claim, including cost segregation and everything in the interim period, never gets recaptured when you dispose of it after 10 years. That ends up boosting your ROI another 2% to 3% per year. Also, your clients have time to do a ground-up build in an OZ fund using deferred tax dollars. By contrast, with a 1031 they generally can't do a ground-up build since they must purchase real estate with an equal or higher value to defer all their 1031 gain.
Installment sales
If your clients don't want the complexity of an OZ fund, they can simply do an installment sale. They simply sell their land with a building on it and take back a seller note for part of it. Many people overlook the fact that even if they don't collect $1 on the note in the year of sale, they are still stuck with 100% of the recapture that they have on the depreciation they've previously claimed. Therefore, they must be sure to collect enough to pay the tax on the depreciation recapture.
The good news is they can defer the rest of the gain until the cash is collected. Their tax basis is allocated to each tranche of collections that they receive. Also, they run the risk that capital gain rates could be higher, and that's also a risk in the OZ world. Vice President Harris just announced plans for a 28% capital gain rate (up from 20%) for taxpayers with incomes above $1 million. We don't know the outcome of the upcoming presidential election, so we don't know what the 2026 tax rates are going to be. Remember, the OZ program defers the capital gain reporting — not the tax.
Delaware statutory trust
The Delaware statutory trust is another vehicle enabling investors to move or shelter their capital gains. DSTs are essentially pre-packaged 1031s that allow multiple investors to pool their money and invest in actual real estate properties (not funds) without the headache of managing the properties, which are often institutional-grade assets such as apartment buildings, office buildings and shopping centers. This collaboration allows your clients to diversify their portfolios and potentially earn higher after-tax returns on their investments.
Regardless of which party wins the White House in November, tax rates are likely to be worrisome for many of your successful clients. It will become more concerning for them in a few years when the multi-trillion-dollar U.S. debt load can no longer be ignored. If your client has gains of $1 million or more from any type of appreciated asset, the OZ program — or one of the other tactics explained above — should be on your short-list of strategies for them to consider. Doing good for others while doing well for your clients and their families: That's a win-win all around — exactly the intention of the bipartisan drafters of the OZ program.
