The Tax Advantages of Opportunity Zone Investments in Puerto Rico

Exotic carribean shore of Puerto Rico Flamenco beach shore

How to minimize and defer your capital gains taxes while still generating total returns as high as 20%.

If you have generated substantial capital gains from your investments – congratulations!

However, you may also be dreading the huge tax bill that’s coming your way.

The good news is that the introduction of Opportunity Zones by the Tax Cuts and Jobs Act in December 2017 can provide you with the perfect investment vehicle to defer your capital gain taxes while using the funds from those gains to invest in high-growth investment opportunities.

What is an Opportunity Zone?

An Opportunity Zone is an economically-distressed community that has been nominated for the designation by each state governor and certified by the Secretary of the U.S. Treasury.

The goal is to incentivize much-needed investments into housing, small businesses, and infrastructure in economically-depressed areas.

The creation of Opportunity Zones allows U.S. investors to defer all capital gains for eight years if the profits are reinvested and held in an Opportunity Zone investment. The capital gains owed will be decreased by 10% if the Opportunity Zone investment is held for 5 years, and decreased by 15% if the Opportunity Zone investment is held by for seven years. To be eligible for the 15% reduction the Opportunity Zone investment must be made by December 31, 2019.

Investors will also be exempt from capital gains tax on any future capital gains on the Opportunity Zone investment if it is held for 10 years.

Opportunity Zone Map
US Map of Opportunity Zones

The benefits of investing in an Opportunity Zone

  • Investors only have to reinvest the gains instead of the entire proceeds from the sale of an asset to take advantage of the tax benefits.
  • Gains from the sale of any capital asset – real estate, stocks, bonds, precious metals, Bitcoin, artwork, etc. – can be rolled into an Opportunity Zone investment.
  • The types of businesses that are eligible for Opportunity Zone benefits are more wide-ranging compared to many previous incentive programs and include investments such as residential rental property businesses, which typically pose lower risks for investors.  

Therefore, one of the most practical strategies to take advantage of this tax bill is to buy older buildings in Opportunity Zones, renovate them at a reinvestment cost that is greater than or equal to the purchase price, and then manage the building as a rental property.

For more information, we’ve created a detailed FAQ on the new opportunity zone regulations from the IRS and what that will mean for investors.

Puerto Rico: An Opportunity Zone with tremendous potential

The IRS recently announced some changes to the Opportunity Zone regulations. As a result, 98.5% of Puerto Rico is now designated as an Opportunity Zone.

Opportunity Zone Map Puerto Rico
Puerto Rico is almost entirely zoned as an Opportunity Zone

Which means investing in a qualified Opportunity Zone project in Puerto Rico is now a highly strategic investment for minimizing capital gains taxes. And since Puerto Rico is part of the U.S., investors are protected by the same property rights and other legal regulations that are applicable on the mainland.

Plus as a U.S. territory, Puerto Rico enjoys legal and economic benefits that are not available to the neighboring Caribbean islands, which present additional opportunities for investors.

A history of debt crises and fiscal mismanagement, coupled with recent natural disasters, has resulted in market conditions in which investors can acquire prime real estate in Puerto Rico at bargain prices.  

Also since it’s easier for U.S. citizens to travel there, it has an increasingly robust tourist industry. Meanwhile, the use of U.S. dollars eliminates any currency risk. In addition, real estate prices in Puerto Rico are substantially lower than comparable properties in the U.S. with the equivalent characteristics.  

You can find beachfront properties at substantial discounts to counterparts on the mainland U.S., and historic old city colonial buildings at almost half the cost of the old city in Cartagena, Colombia and Causco Viejo in Panama.

With a low acquisition cost and a growing vacation rental market, total returns for real estate investment in Puerto Rico can be as high as 15% to 20% prior to taking into account the benefits available under the Opportunity Zone legislation.

Example: Significantly increase your return by investing in an Opportunity Zone

Many crypto investors have experienced substantial capital gain over the past few years.

For example, an investment of $10,000 in Bitcoin in 2010 would have yielded $4,094,400 if it was sold on August 27, 2018, and generate a capital gain of $4,084,400 for the 2018 tax year.

Let’s say this example investor is a single filer living in Miami, Florida (one of the U.S. states with no state or local income taxes nor capital gains taxes) with just under $500,000 of ordinary income in the 2018 tax year.

The capital gain of $4,084,400 will result in a capital gain tax liability of $972,087 at an effective tax rate of 23.8%.  

This 23.8% effective tax rate is comprised of the U.S. federal capital gain tax rate of 20% (maximum rate for single filer) plus the NIIT (net investment income tax) of 3.8% (single filer with cap gains above $200K).

This would translate into nearly $1.0M handed to tax authorities!

What can you do to defer the tax payment and keep more money in your pocket?

Instead of selling your Bitcoin, paying up to 23.8% of the profits in the form of taxes, and stashing the net balance in your bank account (just to watch the money depreciate!), you can make a real estate investment in Puerto Rico and take advantage of high returns plus Opportunity Zone tax benefits.

Let’s go back to our example: Instead of selling the Bitcoin, our investor can invest the $4,084,400 in a Qualified Opportunity Zone fund.

Option1-Lifeafar

Let’s say he or she invested in Plaza Colón Hotel & Suites, Lifeafar’s first Opportunity Zone project in Puerto Rico with a projected IRR of 15.4%.

If the investor rolls over his original investment plus earnings ($4,094,000) from the sale of his Bitcoin in the Opportunity Zone Fund and holds the asset for 10 years, during that time they would receive projected net rental income of approximately $2.9M over such period ($4.5M less 35% U.S. federal income tax on ordinary dividends at the individual taxpayer level). And when the asset it sold, the investor’s share of the total proceeds would be approximately $7.8M, representing a $3.7M capital gain over the initial $4.1M investment.

After eight years of holding the investment in the Opportunity Zone fund, in our example the  investor would pay only 85% of the original capital gains tax liability from the 2018 Bitcoin sale, and after 10 years the investor would owe zero tax on the capital gain in the Opportunity Zone investment.

The net post-tax cash returned to the investor would be approximately $9.9M ($4.1M investment plus $2.9M net rental income plus the $3.7M gain on the sale of asset less $826K of 2018 capital gains tax liability).

Now you may be wondering, how does this strategy compare to investing in the U.S. stock market?

If we use a historical average return of the U.S. stock markets of 7% and our example investor (a Florida resident filing as single with a net income of just under $500K) uses his net cash after a capital gains tax of $3.1M ($4,084,000 cap gain less 23.8%, plus the initial $10K) to purchase stock, he would have netted total earnings of $3.0M in 10 years and would owe $719K in capital gains tax on those earnings, yielding $5.4M in net cash returned taking into account the initial invested capital.

That’s $4.5M less than if they had invested in Plaza Colón Hotel & Suites and received the projected returns.

Want to learn how to defer your capital gains tax by investing in Puerto Rico?

Lifeafar has never been more excited about Puerto Rico and helping investors maximize Opportunity Zone tax incentives, especially with the 15% capital gain reduction expiring December 31, 2019. Interested in being part of our next deal? Enter your information below and someone from our investment team will be in touch.

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