The Downside of a Bull Market
Updated: Sep 15, 2021
Benjamin Franklin once said that 2 things in this world are certain, death and taxes.
If you look at the S&P 500, the returns over the last 10 years have been outstanding. As of 6/30/2021, the 1, 3, 5 and 10 are 40.79%, 18.67%, 17.65%, and 14.01%, respectively. Great returns if you were an investor but at some point you may have to sell. Why? There are many reasons such as locking in gains, offset losses, or use of the proceeds for the purchase of a home. Whatever it may be, the tax man will cometh.
Currently, The short-term capital gains tax rate equals your ordinary income tax rate — your tax bracket and the long-term capital gains tax rate is 0%, 15% or 20% depending on your taxable income and filing status. Long term capital gains are generally lower than short-term capital gains tax rates. There is much debate as to where those tax rates may be in future, but that has yet to be decided.
So what options do you have?
There are several, but one of the most overlooked options are Opportunity Zones that were created under the Tax Cuts and Jobs Act of 2017. Opportunity Zones offer tax benefits to business or individual investors who can elect to temporarily defer tax on capital gains if they timely invest those gains in a Qualified Opportunity Fund (QOF). Investors can defer tax on the invested gain amounts as long as they are held until Dec. 31, 2026. When the tax bill on your initial gain comes due, you are able to reduce the amount of gain recognized by 10%.
If the investor holds the investment in the QOF for at least 10 years, the investor is eligible to elect to adjust the basis of the QOF investment to its fair market value on the date that the QOF investment is sold or exchanged. Effectively, once you achieve a 10-year holding period, depreciation recapture on an Opportunity Zone asset is eliminated and investors pay no taxes on the capital gains.