• Wally Sullivan

Inflation and Basis Step Up Deadline

Inflation has reared its ugly head and there are very few signs that it will abate in the near future. The latest CPI reading showed an increase of 6.2% for the year ending October 2021 which is the highest increase in over 30 years. While investors need to be aware of investments that will perform best during inflationary times, they also need to understand the major benefits of the Opportunity Zone (OZ) tax incentives. While investments can be made into qualified opportunity zones until December 31, 2026, the end of 2021 is the deadline for an investment to be made in a Qualified Opportunity Zone Fund (QOF) that will qualify for a 10% basis step-up and related gain exclusion. This five-year delay in tax payment becomes much more important during inflationary times as it is likely that the tax payment in five years will be much less in terms of the current value of dollars.

Consider the following example:

In the table below we have performed a simple calculation assuming tax rates are not changed in the future. With a $1 million capital gain, investors can pay approximately $290k today or invest the $1 million in a QOF and pay the reduced gain in 2027.

Because of the 10% cost basis step up, QOF investors will pay a $261k capital gain tax in five years thus saving $29k versus paying now. Assuming inflation stays at current levels, that payment in 5 years will equate to $193k in today’s dollar thus yielding an added savings of $68k.

When combining the 5-year delay in payment during an inflationary environment along with the OZ tax benefit investors are saving nearly 10% of their original capital gain by moving into a QOF. Given the mountain of existing government debt and continued government spending habits, inflation may continue to rise making the OZ advantages even greater.

A second important fact of the tax incentive is the increased investment into the QOF due to the delay of payment. As detailed above, investors could invest $1 million today or pay the government $290k and reinvest $710k in any vehicle they choose. To demonstrate the difference, we have simulated the returns from the North Country Growers OZ Fund. Investors

who take advantage of the 5-year delay in tax will have an IRR of 27% while investors who do not take advantage of the tax credit will only earn 20%.

The difference is partly explained by the increase in investment at the start. QOF investors will be investing the full $1 million while other investors will only be able to invest $710k. Most QOF funds, including the one we have simulated, will produce income well above the 2027 tax payment therefore there should be no liquidity crisis for investors.

The last and potentially most lucrative tax benefit is the option for a tax-free sale after ten years. Investors within QOFs can avoid capital gains taxes if the investment is held for ten years while non-OZ investors will pay a capital gain on any sale. In the example above, this benefit is worth over $1 million.

When all these benefits are aggregated in our example above, the QOF investor will net $2 million more than the non-OZ investor despite investing in projects with the same return streams and starting with the same capital gain.

Time is running out on one of the most lucrative tax benefits offered to investors. For a complete list of open QOF projects that we have vetted please email us at

Disclaimer: These materials are not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice. Additionally, these materials are not an offer to sell or the solicitation of an offer to buy any securities or other instruments. Actual transactions described herein are for illustrative purposes only, are presented as of underwriting and are not indicative of actual performance, and were selected based on objective, non-performance factors such as asset-type, geography, or transaction date, among others.

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