“We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard, because that goal will serve to organize and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one that we are unwilling to postpone, and one which we intend to win.” John F. Kennedy, September 12, 1962.
If you’re like me, you’ve spent more than a few evenings this summer watching the trove of documentaries that have been airing on PBS and other outlets about the Apollo program in celebration of the fiftieth anniversary of the first lunar landing on July 20, 1969. I find that watching the story of Project Apollo unfold and witnessing the genius, ingenuity, determination, and bravery of the men and women of NASA making the seemingly impossible become a reality to be both fascinating and inspiring.
Revisiting these events has also been an opportunity to see and hear the speech President Kennedy delivered on September 12, 1962 at Rice Stadium in Houston. The quote above, pulled from that speech, has long been one of my favorite presidential quotes. The speech was intended to rally support for the space program, but the rhetoric used to sell the audacious goal of landing astronauts on the moon and bringing them home safely seems to have a much broader application. Just because a task is hard doesn’t mean that it isn’t worth doing. Shirking difficult challenges and opting for the easy way out is not something that can be counted on to produce long-term success.
Our task at hand, managing investments, is certainly a much easier task, by many orders of magnitude, than the challenges faced by NASA and the Apollo program. While the NASA engineers had to solve problems related to the laws of physics and the nature of human biology, the most difficult challenges facing investors are often internal rather external. Being disciplined investors that make good decisions focused on cogent, long-term strategic plans is our ‘hard’ task at hand. The difficulty comes in battling cognitive biases, such as Recency Bias, Hindsight Bias, or Bandwagon Bias (also known as Herding), that are constantly pulling investors in the wrong direction. We are all subject to falling victim to these biases. They are constantly pushing us towards the seemingly easier path and are the most difficult challenges facing most investors.
Recent market performance is providing a plethora of cognitive bias challenges for investors. As has been the case for much of the last 10 years, the S&P 500 was the best performing market index in the second quarter, up 4.30%. This despite some significant intra-quarter volatility. That brought the S&P 500’s year-to-date performance up to 18.54%. This is where our cognitive biases kick in. Recency Bias will lead investors to extrapolate this performance into the future leading them to overweight large-cap US stocks. Hindsight Bias will whisper in the investor’s ear that everyone knew that the S&P 500 was the best place to be – it was obvious. And the Bandwagon Bias will urge investors to jump on board the US large-cap stock train; everyone else has and they are all doing better than you. This is the time that doing the hard thing, maintaining a disciplined long-term approach grounded in fundamental investment principals, becomes most difficult. And it is why investors should be prepared, as Lady Macbeth said, to “screw their courage to the sticking place,” and prepare to do that which is hard, not that which seems easy.
The Tax Cuts and Jobs Act passed in late 2017 provided for tax incentives designed to encourage capital investment in local “zones” in an effort to spur economic development and job creation in distressed areas. The Opportunity Zone, or O-Zone, program encompasses over 8,000 census tracts and more than 30 million residents across the U.S. Texas has approximately 600 Opportunity Zones, with nearly 30 in the DFW area. It is estimated that these new tax incentives will provide over $100 billion of investment in qualifying O-Zones. For investors, income taxes levied on future expected gains can be significantly reduced if the qualifying investment is held for at least 5 years. In addition, if an O-Zone investment is held for longer than 10 years, the gain, which would otherwise be taxable, will be tax-free. Other elements of this new tax law include the chance to reinvest gains incurred from other sales into O-Zone investments and the deferral of any tax that would have been paid for up to seven years. For example, if a business is sold in early 2019 and a taxable gain of $250,000 is recorded, the $250,000 gain can be reinvested in an O-Zone qualified investment fund thereby deferring the taxes due on this $250,000 until a later date. So, there is immediate income tax savings and potential future additional tax savings or elimination of taxable gain, depending on how long the O-Zone investment is held. To provide further guidance, the IRS issued Proposed Regulations in October 2018 as well as April 2019.
Who should consider O-Zone investments? Anyone who has already incurred a taxable gain from sale of any type of investment (no more than 180 days prior to making a qualified Opportunity Zone investment) or who anticipates having a taxable gain in the next 180 days could be a good candidate. Taxpayers can benefit by reinvesting a portion of or the entire gain incurred into a qualified O-Zone fund within the 180-day time requirements. The gain can be from marketable securities, real estate, private investments, sale of a closely held business, gains received through partnership investments, etc. Only the portion of the gain that is reinvested would be eligible for future tax deferral, depending on the holding period of the qualified O-Zone fund investment.
What are the potential rewards? Current year income tax is deferred for any qualified gain invested in an O-Zone fund. For example, if taxes of 20% on $500,000 of gain ($100,000 of income taxes otherwise due) are expected, the taxpayer/investor could choose to invest this $500,000 (or any portion of this gain) in a qualified O-Zone fund. As such, the $100,000 of capital gains taxes would be deferred to a later date and the $500,000 invested would escape taxation if the O-Zone investment is held for a minimum of 10 years. Thus, the tax deferral is immediate as well as the potential savings in the future if the O-Zone requirements are met. Another benefit of the new tax law is the broad range of qualifying O-Zone investment types that qualify (e.g. real estate, equity, loans or other types of legal structures). More IRS guidance is expected to further clarify these criteria.
What are the risks? General investment risk is inherent in any O-Zone fund. While the tax benefits are nice to have, if the O-Zone fund is not successful, any deferral or elimination of taxes would be offset by an unsuccessful investment. It is important to evaluate the investment fund without the tax incentive program benefits being included. If the diligence suggests an investment, the tax savings should be viewed as an added incentive. In addition to general investment risk, there is the risk of a tax law change in the next 10 years that could make this program less beneficial for all taxpayers or select taxpayers above a certain income threshold. Thus, there is the possibility of law revisions which could potentially remove some of the benefits. This needs to be considered before investing.
How do you get more information? Individual circumstances are important to consider when determining whether an Opportunity Zone Investment is appropriate. RGT Wealth Advisors is actively researching the new O-Zone rules and regulations and can provide more analysis and assistance in determining whether these investment funds may be appropriate for an investor. So far, RGT has seen qualifying O-Zone investment funds in NY, CA, TN and AZ. Please contact us for additional discussion on Opportunity Zone investing.