‘Time Travel’ With Opportunity Zone Funds To Manage 2021 Tax Liabilities
Welcome to the New Year 2022! Fortunately for many crypto and other blockchain investors, 2021 was a banner year. Nonetheless, some tax bills may be coming due. For those investors who realized capital gains in 2021, there are several upcoming due dates for U.S. federal income taxes. It is too late for investors to implement many of the traditional tax strategies for managing 2021 taxes that had to be completed by December 31, 2021. However, there are some strategies that allow for “time travel” – i.e., transactions in 2022 that can impact 2021 tax liabilities. In a prior article, we highlighted one such strategy involving Opportunity Zone (“OZ”) fund investments, including investments in blockchain infrastructure companies such as Blockchain OZ Fund. This article supplements the prior one with information about upcoming 2022 tax due dates and how investors should think about Opportunity Zones before those due dates.
Subject to limited exceptions, taxpayers are required to pay taxes as they earn or receive income during the year, either through estimated taxes or withholding (such as withholding from a salary). If the amount of income tax withheld is not enough, or if the taxpayer receives other income such as capital gains, the taxpayer may have to make estimated tax payments.
Estimated tax payments are due as follows:
- April 15 due date – for income from January 1 to March 31
- June 15 due date – for income from April 1 to May 31
- September 15 due date – for income from June 1 to August 31
- January 15 due date for income from September 1 to December 31 (for 2022 this due date would be January 18, 2022 due to the Martin Luther King Holiday)
The IRS can charge penalties and interest for underpayments of withholding and estimated tax or late tax payments. To avoid such penalties, the following are two “safe harbors” to calculate the estimated tax for 2021, which should be the smaller of:
1. 90% rule – 90% of taxpayer’s total expected tax for 2021; this requires calculations of a taxpayer’s expected taxes based on available information or estimates of income, deductions, and credits for 2021
2. Prior year “safe harbor” – 100%* of the total tax shown on the taxpayer’s 2020 return.
*Note: Subject to exceptions, the taxpayer should substitute 110% for 100% above if the taxpayer’s adjusted gross income for 2020 was more than $150,000 ($75,000 if the taxpayer filing status for 2021 is married filing separately).
Any remaining tax not covered by the safe harbors above is due by April 18, 2022.
Impact of Opportunity Zone Investments
As discussed in the prior article, investing in an OZ fund can potentially provide tax benefits in addition to the returns from the underlying investment. Specifically, an investor can potentially defer until December 31, 2026 any taxes (including 2021 taxes) due on any capital gains invested in an OZ Fund. In effect, this is akin to receiving a tax-free loan from the government equal to taxes otherwise due, without having to pay interest or share in the profits earned on the loan. Operationally, taxpayers participate in an OZ by investing prior capital gains into an OZ Fund”) within certain deadlines. Generally, taxpayers have 180 days to invest a prior gain in an OZ fund. The period can be significantly longer for those realizing capital gains through partnerships (including DAOs), RICs, REITs, or certain other investment vehicles. Because of the 180-day or longer “look back period”, taxpayers can effectively engage in transactions in 2022 that impact 2021 taxes – i.e., “time travel”.
For example, if a taxpayer in the highest 37% tax bracket realized a short-term capital gain of $1 million on September 30, 2021 from a disposition of a cryptocurrency, the taxpayer can defer the gain (and resulting 2021 tax of approximately $370,000) by investing $1 million in an OZ fund by March 28, 2022 (i.e., 180-days from the capital gain date). This deferred tax can potentially impact the amount of estimated and final taxes due by January 18, 2022 or April 18, 2022.
There are other tax benefits along with the potential investment returns and societal benefits from investing in OZ funds. Unlike most other OZ funds focused on traditional real estate and the few that are focused on bitcoin mining, Blockchain OZ Fund is one of the few investment vehicles that would allow investors to get exposure to potential returns of reinvesting blockchain and cryptocurrency gains back into blockchain, Metaverse, Web 3.0 ecosystems on a tax-advantaged basis.
Contact Norm Hannawa from Blockchain OZ Fund at firstname.lastname@example.org for more information.
As mentioned in the prior article, regardless of the value of tax benefits, any OZ investment must make sense from an economic standpoint, and we advise investors to consider all of the financial aspects of such an investment. ↑
If the due dates fall on a Saturday, Sunday or legal holiday, the payments are due the next business day. ↑