Using Opportunity Zone Funds to Defer Taxes on the Sale of Your Group Practice or DSO

Sometimes opportunity can knock so quietly that it goes unheard.

If  you are an investor who has or will soon generate capital gains from selling stock, bonds, a company, real estate, or any other asset, you should listen in – and act fast.

For those of you who are considering an exit from the sale of your practice or DSO this would apply to you as well and may impact your decision as whether to sell given this option.

Opportunity Zones Funds, possibly one of the most positive developments of the Tax Cuts and Jobs Act of 2017, will provide the private sector with incentivized opportunities to invest in and help revitalize economically challenged communities while earning significant tax advantages, including the deferral of some or all of one’s capital gains from federal taxation.

If investors invest their capital gains into a Qualified Opportunity Fund (QOF) within 180 days of sale, they can participate in an attractive and lucrative long-term investment strategy that will put their capital to use while making both an economic and social impact, and potentially earning a major payoff.

The reality here is that what helps to grow one’s bank account can actually be a growth opportunity for everyone. 

The Tax Cuts and Jobs Act mandated that both state and federal governments work to create Opportunity Zones nationwide that would encourage private investment in low-income census tracts.

At least 90 percent of a QOF’s assets must be dedicated toward property ownership, including stock, partnership interests, and business properties, within such designated Opportunity Zones nationwide, including but not limited to affordable housing, commercial real estate development, improving infrastructure, renewable or traditional energy, startup businesses, and the expansion and revitalization of existing businesses.

This would include using capital gains to purchase or start a practice in a QOF as well.

Designed to run through December 2047, QOF’s would allow investors to reduce their total tax liability by deferring and reinvesting an unlimited amount of their realized capital gains from the sale of assets into these investment vehicles.

And, though it is possible to reinvest all or a portion of one’s capital gains into any Opportunity Zone within the U.S., QOF’s also would provide investors with a way to make a local impact by increasing the value in the nearby communities.

Here is why this is both a philanthropic and lucrative idea:

An investor holding an investment within an Opportunity Zone for at least five years would be entitled to a 10 percent increase in the tax basis of their investment of the deferred gain; for at least seven years, 15 percent; and, after ten years, there would be no federal capital gains tax on the appreciation of the invested capital gain within a QOF.

That means, for example, if one were to invest $100,000 of capital gains into an Opportunity Fund on December 31 of this year, they likely would see more than $40,000 in their after-tax return after ten years as opposed to having invested their capital gains in a traditional stock portfolio.

Let’s do the math.

Say, for example, that you  purchased a property for $250,000 in 2016, and sold it this year for $350,000.

With a traditional stock portfolio and a tax rate of 23.8 percent, you would have to pay a capital gains tax of $23,800.

By investing in a QOF, you can instead defer that tax until December 31, 2026 while continuing to earn a return on your total investment. Deferring his tax liability allows you the ability to earn returns for a longer period of time, using monies that otherwise would have been used to pay taxes upfront.

Then, in 2026, you would now only be expected to pay $20,230 in capital gains tax, having saved $3,570 by reducing your tax liability by 15 percent for having invested in the QOF for seven years. And, when you sells your investment in 2028, you will not pay additional capital gains taxes on the invested gains.

With a traditional stock portfolio, you would have to pay taxes on the sale. 

Investors who wish to sell their investment in a QOF before 2026 would also have the option of retaining their tax deferral as long as the proceeds of such a sale are reinvested into another QOF within 180 days.

As always, there are some things to consider.

In the event that you are considering selling your practice, only the capital gains would qualify for this exemption. This means that to the extent that part of the purchase price is allocated to patient receivables, dental supplies, a restrictive covenant or fixed assets that are subject to depreciation recapture the value assigned to these items would still be subject to income tax.

QOF’s must be structured as corporations or partnerships, including limited liability corporations, ‘C’ and ‘S’ corporations, registered investment companies, real estate investment trusts, and/or trusts and estates.

All or a portion of one’s capital gains must be reinvested into a QOF within 180 days of an asset sale, with the window beginning on the date when the gain would be recognized for federal income tax purposes.

Properties in an Opportunity Zone only qualify if they are acquired after December 31, 2017.

The proposed regulations are expected to be formalized in January 2019 – and, as of yet, are still subject to revision – we expect increased interest and optimism in QOF’s over the coming months as more investors seek to diversify their portfolios with professionally managed pooled funds coming on line.

We also believe that the tax incentives offered through the Opportunity Zone program should help improve the economic market overall, as investors both invest in and help to rebuild low-income rural and urban communities throughout the nation.

So, if you are looking to sell an asset in the near future, consider investing in a QOF – it will not only allow  you defer your capital gains taxes, but it will also allow you to compound the earning power of your dollars while making a lasting impact.

As with many investments, this type may not be suitable for everyone when considering the fact that you are making an illiquid investment while also investing in a transitional area so caution should be exercised.