When Congress passed the Tax Cuts and Jobs Act of 2017 into law, it represented the largest piece of tax reform legislation in more than three decades. Not surprisingly, much has been written about the main provisions of the new tax law since it was enacted, such as the decrease in tax rates for most tax brackets, the increase in the standard deduction amount, and the doubling of the Child Tax Credit.
But there are other, less-explored aspects of the new tax law that are of significant potential benefit to individuals and families of wealth. In the following, Tony McEahern and Dan Terlep of Cresset explore five opportunities provided by the tax law changes and how they may be of benefit.
Qualified Opportunity Zones (QOZS)
One of the most exciting and potentially impactful opportunities created by the new tax law are Qualified Opportunity Zones (QOZs). More than 8,000 of these economically depressed zones across all 50 states were created as part of the tax law to incentivize private investments in these areas and provide potentially significant tax benefits to investors who make qualified long-term investments in them. In short, QOZs represent a potential win-win scenario for both impact-oriented investors and communities that need revitalization.
The three main tax benefits for investors who invest in QOZs are a tax deferral on the initial capital gain that they invest into a QOZ, a potential decrease of that capital gain of up to 15 percent, depending on when the investment is made and how long they hold their QOZ interests, and the permanent exclusion of additional capital gain from the appreciation of the actual QOZ investment, assuming the interests are held more than 10 years. To the extent that the QOZ funds invest in real estate, another potential tax benefit is the depreciation deduction. Last but certainly not least, QOZs also offer a measurable form of impact investing for investors who have a passion for making a difference. In summary, for investors who appreciate both tax efficient investments (e.g. the QOZ benefits can more than double after-tax gains) and a form of impact investing, QOZs may be the perfect solution.
Section 1031 Or “Like-Kind Exchanges”
Section 1031 exchanges allow taxpayers to defer tax upon the sale of particular assets if the taxpayer is able to acquire “like-kind” property within certain time frames, and if they use multiple Section 1031 exchanges, they can defer the tax indefinitely. Most often, Section 1031 exchanges are used with real estate, but taxpayers have also used them for assets such as artwork, airplanes, yachts, collections, among other assets. However, the new tax law now limits the use of Section 1031 exchanges solely to real estate. As such, taxpayers who have used 1031 exchanges for non-real estate assets will now need to look elsewhere for capital-gain deferral strategies, such as Qualified Opportunity Zones.
Gift, Estate And Generation Skipping Transfer Tax Updates
When you make certain types of transfers (which can happen while you are alive or at death) there are three types of taxes that may potentially be due to the federal government: the gift tax, the estate tax, and the generation skipping transfer tax (GST). All of those taxes have threshold amounts below which you can transfer without these taxes being imposed (known as the “exemption amount”). As a result of the new tax law, in 2019, the “lifetime” exemption amount increased to $11,400,000 for individuals, and $22,800,000 for married couples.
New Tax Deduction For Qualified Business Income
Of special interest to entrepreneurs, self-employed individuals, and investors, the new tax law also includes a potentially significant tax benefit by allowing them to deduct 20 percent of their qualified business income (QBI). Here are the basics of how it works. The new rule provides many individuals with a deduction for QBI from a qualified trade or business operated directly or through a pass-through entity. The deduction has two parts. First, there is a deduction of up to 20 percent of QBI from a business operated as a sole proprietorship or through a partnership, S corporation, trust or estate (the deduction is limited by several factors, including total taxable income). Second, there is a deduction of up to 20 percent of combined qualified real estate investment trust dividends and qualified publicly traded partnership income. The sum of these two amounts is referred to as the combined QBI amount. The deduction is available, regardless of whether an individual itemizes their deductions or takes the standard deduction.
Qualified Small Business Stock (QSBS)
Although not technically part of the new tax law passed in 2017, it is worth mentioning the tax reform passed in 2015 allows investors a full tax break on capital gains associated with the sale of Qualified Small Business Stock (QSBS). While certain tax benefits of QSBS have been around for some time, the 2015 tax reform significantly expanded the tax benefits. Of course, not all stock is considered QSBS. Certain requirements must be met, such as the stock must be originally issued from a U.S. corporation, the tax basis in the gross assets of the corporation needs to be less than $50 million, the stock is required to be held for more than five years, and certain businesses don’t qualify, such as professional organizations, banking and financial businesses, farming businesses, and certain hospitality businesses. Nevertheless, the tax breaks offered by the sale of QSBS can provide a very attractive opportunity for investors who directly invest in small companies.
Tony McEahern is senior managing director of wealth planning for Cresset. Dan Terlep is senior managing director of financial and tax strategy for Cresset.
