Business Tax

The 2017 Tax Cut and Jobs Act created Opportunity Zones. These special economic zones give investors and business-owners a chance to do some good in a depressed area, make some money, and obtain some significant tax benefits. That is a pretty powerful combination.

For this reason, OZ investments have a significant edge over traditional 1031 exchanges. If owners exchange one investment property for another, they may reap some capital gains tax breaks. But 1031 exchanges only apply to real property, OZ investments apply to any capital asset. Additionally, 1031 tax breaks usually only apply when the owner dies.

However, unlike 1031 exchanges, which are rather straightforward, there are a number of intricate rules concerning OZ investment tax breaks. A certified tax coach has the tools you need to maximize these benefits.

The Basics of Opportunity Zone Investments

There are more than 8,500 opportunity zones throughout all fifty states and Puerto Rico. Most, but not all, of them are in the South and Mountain West. The IRS will certify an area as an Opportunity Zone if:

• The state or territorial government nominates it, and
• The area has a 20 percent or higher poverty level, or
• Median household income is at least 20 percent lower than the nearby areas.

In practical terms, these numbers mean that Opportunity Zones are usually not hopelessly depressed areas. Many times, they are downtown neighborhoods that need a redevelopment jump-start. Other times, they are places where suburban sprawl is approaching, but has not quite arrived yet.

Types of Investment Opportunities

In general, either people or companies can invest in Qualified Opportunity Funds. A QOF directs invested funds into the Opportunity Zone. This setup decreases investor risk and helps ensure that more money goes to the Zone itself. In fact, in most cases, at least 50 percent of the QOF’s revenue must come from the OZ, and at least 90 percent of investors’ money must go into the Zone.

Some QOFs are direct funds. These entities operate businesses inside the OZ. Some vice or sin businesses, like massage parlors and liquor stores, are not eligible for OZ status. Other QOFs are indirect investment funds. The investor buys an equity interest in the QOF, which then reinvests this money into an Opportunity Zone business. According to complex IRS rules, at least 63 percent of all indirect investments must go to Qualified Opportunity Zone Business Property. That’s a good thing if, as is often the case, the QOF is a diverse, multistate entity. Some additional safe harbor provisions give indirect investors even more flexibility.

Tax Benefits

As mentioned, OZ tax benefits generally involve capital gains tax breaks. The three major ones are:

• Deferral: Investors need not pay capital gains tax on any Opportunity Zone investment property until 2027 or until they sell or exchange any portion of the investment.
• Exclusion: Lawmakers want to encourage long-term investment in these areas. So, investors who keep their money in the OZ for at least five years may exclude 10 percent of their capital gains tax. That exclusion increases to 15 percent after seven years.
• Basis: This tax break is probably the big one. If investors hold the capital asset for more than ten years, the IRS calculates basis on the date of sale as opposed to the date of purchase. So, the investor basically pays no capital gains tax on the property’s increased value.

State tax rules may or may not be the same. So, it may be necessary to track the investments separately to maximize tax benefits.

To learn more about this tax break, and others like it, contact a certified tax coach near you.

Critical Choices: How the Business Entity You Select Impacts Your Taxes

Entrepreneurs have a long list of special opportunities to save on taxes. However, your eligibility for some tax breaks depends on the decisions you make as you are planning and launching your business. One of the most critical choices is which business entity you will operate under. The Amazon Best Selling book, The Great Tax Escape, walks you through each of your options, spelling out the benefits and drawbacks of the most common business structures.

Business Entity Basics

It’s no surprise that you must pay taxes on any income your business generates, but you might not realize that the same income can be taxed differently depending on how your business is organized. While some types of businesses are considered separate taxpayers from their owners, others require that you include your business income on your personal tax returns.

Your tax rates aren’t the only thing impacted by your choice of business entity. The structure you select affects whether you are personally responsible for business debts and whether you can be held personally liable if the business is sued. When your business exists as a separate entity, the business itself can apply for credit, and these types businesses can continue to operate when you decide to move on or retire.

These are a few of the most common options:

Sole Proprietorships and Partnerships

When you are starting out and working alone, it is easy to operate as a sole proprietorship. Essentially, you and your business are one and the same for tax and legal purposes. Simply register your business name with the state, and you are ready to launch. You can still have employees as a sole proprietor, but you own the entire company.

The simplicity of this structure makes it quite popular, but it isn’t always the best choice for entrepreneurs. Business income is treated the same way as other personal income for tax purposes, and you assume full liability for all business debts and legal issues. That puts your personal assets at risk.

Though there is slightly more paperwork involved, a partnership is quite similar to a sole proprietorship. Taxes and legal liability are the responsibility of all partners, and partners can be sued individually or collectively for the actions of one business owner.

Limited Liability Companies (LLC)

It is common to see the initials LLC after many small and medium-sized business names, and there is a good reason for that. LLCs offer business owners many of the protections that larger corporations enjoy, without the complexity and cost associated with incorporation. With LLCs, business owners are considered separate from the business itself for the purpose of taxation and legal liability. This can lead to significant tax savings, and it protects personal assets from business-related debts and lawsuits.

Of course, setting up an LLC is more complicated that operating as a sole proprietor, so some entrepreneurs choose to hold off on this step until the business begins to be profitable. Your choice of business entity can dramatically impact your bottom line tax bill, and it will affect your long-term level of risk as the organization grows. To learn more about your options for structuring your business, contact us today by calling 801-553-1120 or request your free consultation online now. As a thank you for scheduling your consultation, we’ll provide a free tax planning book, The Great Tax Escape.

This addition to the Internal Revenue Code allows taxpayers to deduct 20 percent of any Qualified Business Income they receive during a tax year. But the exact definition of QBI had long been uncertain. IRC Section 162 states that a trade or business “generally includes any activity carried on for the production of income from selling goods or performing services.”

That’s not a very helpful definition, especially in the real estate ownership context. IRS Notice 2019-07 substantially clarified the picture. It establishes a safe harbor for real estate rental income. If such money meets the 2019-07 test, it is automatically QBI. However, the safe harbor provisions are still rather subjective, and there are some limitations.

Certified tax coaches may provide the information you need in these situations. These professionals help navigate the Tax Code’s complex provisions.

Specific Requirements

Instead of the income itself, or the property itself, the real estate safe harbor provision focuses on the landowner’s activities. If the owner spends at least 250 hours a year on rental activity, any income from that property is QBI and eligible for the 20 percent deduction. Rental activity includes things like:

• Making the property available for rent or lease
• Advertising the opening
• Verifying rental application information
• Negotiating lease terms
• Executing completed leases
• Collecting rent
• Managing the property
• Supervising employees or contractors

The owner can delegate these functions to partners, employees, or independent contractors. So, if the owner hires a part-time maintenance worker who spends Saturday mornings fixing sprinkler heads, servicing tenant appliances, and so on, those 200 hours count toward the 250-hour minimum.

Property procurement, improvement, and investment activities specifically do not count as rental activities. Time spent commuting to and from the property does not count toward the 250-hour minimum either.

There are also some exclusions. Owner-occupied property, even if it was only for one day in the year, never qualifies for the 199A income deduction. Triple net lease property (the tenant pays rent, utilities, taxes, and insurance) never qualified either.

Practical Considerations

For the most part, multi-unit property usually qualifies for the safe harbor allowance. It does not matter if the property is residential or commercial. It also does not matter if the owner intends to sell the property or move into it at a later date.

Single-unit property probably will not qualify. It’s very difficult to meet the hourly requirement in these situations. 250 hours is over six weeks of full-time work. Additionally, the aforementioned residency and lease restrictions often apply.

Contact a certified tax coach near you to learn more about the QBI deduction.