Tax Benefits of Starting a Small Business in an Opportunity Zone

Opportunity Zones, created by the 2017 Tax Cuts and Jobs Act, provide significant tax incentives to small businesses and investors who choose to establish their operations in designated economically distressed areas. These tax-efficient areas offer numerous benefits, ranging from capital gains deferral to fostering community development, job creation, and economic revitalization.

As an all-online boutique tax firm, Wyntax is dedicated to empowering small business owners with the insights and tools required to thrive – and starting your venture in an Opportunity Zone can provide substantial tax benefits and advantages. In this guide, we will explore the process of leveraging Opportunity Zones to realize the tax incentives and impacts for your small business.

Capital Gains Deferral

One of the primary benefits of investing in an Opportunity Zone is the deferral of capital gains tax. Small business owners or investors who have recently sold an asset can invest the realized capital gains into an Opportunity Fund, which in turn is utilized to support businesses in an Opportunity Zone. This strategic investment allows the investor to defer tax payments on those gains until the earlier of the sale of the Opportunity Fund investment or December 31, 2026.

Small business owners can reinvest capital gains tax to support further business growth within the Opportunity Zone by deferring capital gains tax. This tax deferral maximizes cash flow and accelerates your business's development and expansion in the designated area.

Partial Capital Gains Exclusion

Another appealing tax benefit of starting a small business in an Opportunity Zone is the partial exclusion of capital gains. When investing in an Opportunity Fund, investors can reduce their overall capital gains liability if they meet specific holding period requirements. These partial exclusions work as follows:

1. 5-Year Holding Period: When an Opportunity Fund investment is held for at least five years, the investor can exclude 10% of their initial deferred capital gains from taxation, effectively reducing their tax liability by 10%.

2. 7-Year Holding Period: If the Opportunity Fund investment is held for at least seven years, the investor can enjoy an additional 5% exclusion, totaling a 15% reduction in original capital gains tax liability.

However, note that due to the December 31, 2026, tax deferral deadline, investors must initiate their investment before the end of 2021 to take advantage of the full 15% exclusion for the 7-year holding period.

Eliminating Tax on Future Gains

Arguably the most significant tax advantage of investing in an Opportunity Zone is the potential for eliminating federal tax on future capital gains generated from the investment itself. If a small business owner or investor holds their Opportunity Fund investment for at least ten years, they can benefit from a step-up in basis for the investment, increasing its cost basis to the fair market value at the time of sale. As a result, investors avoid paying any federal tax on growth in the value of their Opportunity Fund investment.

This tax benefit incentivizes long-term investment in the Opportunity Zone and supports the sustainable growth and economic revitalization of the community while enabling small business owners to maximize their return on investment.

Community Development and Economic Revitalization

Starting a small business in an Opportunity Zone not only offers several tax benefits, but also has a positive impact on the local community and economy. By establishing your business in one of these designated economically distressed areas, you actively contribute to developing infrastructure, creating jobs, and fostering economic diversification. These factors, in turn, strengthen and uplift the community, making Opportunity Zones a mutually beneficial strategy for both small business owners and the communities they serve.

Some ways small businesses in Opportunity Zones contribute to community development and economic revitalization include:

1. Job Creation: Small businesses in Opportunity Zones create job opportunities for local residents, helping to reduce unemployment rates and improve overall economic well-being.

2. Infrastructure Improvements: Opportunity Fund investments often lead to improved infrastructure, providing better access to resources and services for local residents.

3. Economic Diversification: The growth of small businesses in economically distressed areas promotes increased economic activity and diversification, making the community more resilient in the face of economic fluctuations.

Conclusion

Starting a small business in an Opportunity Zone offers numerous tax benefits, including capital gains deferral, partial capital gains exclusion, and eliminating tax on future gains. These financial incentives not only maximize business growth and profitability but also contribute to the welfare and development of economically distressed communities. By leveraging Opportunity Zones, small business owners can invest in economically disadvantaged areas, nurturing growth and revitalization while benefiting their financial position.

Wyntax is dedicated to assisting small businesses in navigating the intricacies of Opportunity Zones, providing expert guidance and tailored business tax solutions to ensure optimal outcomes. Contact us today to learn how we can help your business thrive in an Opportunity Zone and capitalize on its tax benefits for long-term success.