The 2017 Tax Cuts and Jobs Act (TCJA) created the federal “Opportunity Zones” (“OZ”) program, a new tax incentive program for investments in low-income communities. In order to utilize the benefits of this new program, the law requires that taxpayers invest capital gains into a new type of investment vehicle known as a “Qualified Opportunity Fund” (“QOF”).
For additional observations, insights and discussion, read this blog post: "How Does Opportunity Zone Business Investment Work?"
To maintain QOF status, a fund must invest at least 90 percent of its assets in Qualified Opportunity Zone (“QOZ”) property. The statute identifies three types of assets that are QOZ property:
- Original issue stock in a corporation that is (or will be) a QOZ business, acquired after Dec. 31, 2017;
- A capital or profits interest in a domestic partnership interest that is (or will be) a QOZ business, acquired after Dec. 31, 2017; and
- QOZ business property.
Proposed Opportunity Zone Regulations
On October 29, 2018, the IRS and Treasury Department published the first set of proposed regulations (74 pages) which provided guidance regarding gains eligible for deferral, the types of taxpayers eligible to elect gain deferral, investments in a QOF, 180-day rule for deferring gain by investing in a QOF, attributes of included income when gain deferral ends, and special rules.
On May 1, 2019, the IRS and Treasury Department published a second set of proposed regulations (169 pages) which provided guidance regarding Qualified Opportunity Zone (“QOZ”) business property, the treatment of leased tangible property, QOZ business, special rules for section 1231 gains, relief from the 90 percent asset test, the amount of an investment for purposes of making a deferral election, events that cause inclusion of deferred gain, and consolidated return provisions.
These proposed regulations provide potential fund sponsors and administrators with additional insight into OZ program operational rules.
In addition, the IRS updated their “Opportunity Zones Frequently Asked Questions.”
Answers to a few key questions regarding the OZ program are provided below.
What does “Substantially All” mean for Opportunity Zones?
The term “substantially all” appears in several parts of the statute. The proposed regulations define this term as follows:
- For use of QOZ business property, at least 70 percent of the property must be used in a QOZ.
- For the holding period of QOZ business property, tangible property must be QOZ business property for at least 90 percent of the QOFs or QOZ business’s holding period.
- A corporation or partnership must be a QOZ business for at least 90 percent of the QOFs holding period.
What does “Six month Exception” mean for Opportunity Zones?
The proposed regulations allow a QOF to apply the 90 percent asset test without taking into account any investments received in the preceding 6 months when such amounts are held in cash, cash equivalents, or debt instruments with terms of eighteen months or less.
What does “One Year to Re-Invest” mean for Opportunity Zones?
The proposed regulations provide a QOF with a “reasonable period of time” to reinvest the return of capital from qualified investments by allowing one year from the distribution, sale, or disposition of QOZ stock, partnership interest or business property to re-invest the proceeds into new qualified property. During this time, the amounts must be held in cash, cash equivalents, or debt instruments with terms of eighteen months or less.
What does “At Least 50 Percent of Gross Income” mean for Opportunity Zones?
The statute requires that at least 50 percent of the gross income of a QOZ business must be derived from the OZ in order for it to be a QOZ business. The proposed regulations provide 3 safe harbors and a facts and circumstances test for determining whether sufficient income is derived from a trade or business in a QOZ for purposes of this test. Businesses only need to meet one of these safe harbors to satisfy this test.
- At least 50 percent of the services performed (based on hours) for such business by its employees and independent contractors (and employees of independent contractors) are performed within the QOZ;
- At least 50 percent of services performed (based on amounts paid) for such business by its employees and independent contractors (and employees of independent contractors) are performed within the QOZ; and
- The tangible property and the management or operational functions performed for the business in a QOZ are each necessary to generate 50 percent of the gross income of the trade or business.
Connect with the Opportunity Zones Program Specialists at Freed Maxick
The proposed opportunity zone investment regulations answer many questions that were holding back QOF investments by taxpayers, especially in connection with the QOF exit rules. Taxpayers and fund sponsors should connect with opportunity zone advisors who are well versed on the proposed regulations and the remaining unanswered questions as they contemplate making a QOZ investment, becoming a fund sponsor, or creating their own self-managed fund.
If you’re considering a QOF investment, becoming a fund sponsor, or establishing your own self-managed fund, schedule a no cost or obligation discussion with our opportunity zone consultants by clicking on the button or contact Don Warrant, CPA, Tax Director at Don.Warrant@freedmaxick.com to discuss further.View full article
A discussion of Qualified Opportunity Fund (QOF) benefits, eligibility requirements, and action steps
The Tax Cuts and Jobs Act of 2017 (TCJA) created a new tax incentive program for taxpayers to defer capital gains tax by investing in certain economically distressed areas known as “Opportunity Zones.”
Tax Director Don Warrant Speaks Out on Opportunity Zone Opportunities. Listen here.
Qualified Opportunity Zones (QOZ) are areas nominated by the governors of U.S. states and territories based on Census data that identify low-income communities. A map of the communities can be found on the U.S. Treasury’s CDFI Fund web page.
At this point, the maximum number of eligible zones has been nominated by each state and the current law does not allow for additional or revised designations, even if future census data might suggest that the boundaries have shifted. In other words, the universe of Opportunity Zones has been determined and is expected to remain stable unless the law changes.
Opportunity Zone Investment Program Tax Incentives
The Opportunity Zones program tax incentives include deferral of capital gains tax from the sale or exchange of assets with unrelated persons and capital gains tax exclusion. To access the tax incentives, taxpayers (including corporations, partnerships, individuals, estates and trusts), have a 180 day period in which to reinvest capital gain proceeds in a Qualified Opportunity Fund (QOF). The beginning of the 180 day period varies based on the type of taxpayer and the classification of the gain as capital or section 1231.
The Opportunity Zone tax incentives are as follows:
- The capital gain that would have been recognized in the year of the sale is deferred until the QOF investment is sold or exchanged, or until Dec. 31, 2026, whichever is earlier;
- 10 percent of the deferred capital gain is permanently excluded from federal taxable income after holding the QOF investment for 5 years;
- An additional 5 percent of the deferred capital gain is permanently excluded from federal taxable income after holding the QOF investment for 7 years; and
- Any appreciation in the QOF investment is permanently excluded from federal taxable income after holding the QOF investment for 10 years.
How to Make a QOF Investment
To make a QOF investment, taxpayers must first generate a gain from the sale or exchange of assets that will be treated as a capital gain for federal income tax purposes. The federal income tax treatment of a net section 1231 gain is not determined until the last day of the tax year. Capital gains must be invested in a QOF within the required 180 day period.
The tax incentives apply to the portion of capital gains that are timely invested in a QOF. Any investment of non-capital gains are treated as a separate investment by the QOF since they don’t qualify for the tax incentives.
A QOF is an entity organized as a corporation or partnership for the purpose of investing in QOZ property (other than another QOF). The QOF does not need to be located in an Opportunity Zone. However, at least 90 percent of the QOF’s assets must be QOZ property for substantially all of the QOF’s holding period of such assets. QOZ property includes QOZ stock, QOZ partnership interest, and QOZ business property.
The QOZ stock or partnership interest must be acquired by the QOF after Dec. 31, 2017 for cash provided the entity is a QOZ business, or is being organized as a QOZ business. Alternatively, the QOF may acquire QOZ business property.
Taxpayers who are considering a real estate development project located in a QOZ or considering the operation of a business located in a QOZ can establish their own QOF. Alternatively, taxpayers seeking the tax incentives provided by the Opportunity Zones program can invest capital gain proceeds in a QOF that is professionally managed by others. In that case, taxpayers should perform the appropriate amount of due diligence before making the investment to assure the investment will operate as required in accordance with the program rules.
When to Make an Opportunity Zone Investment
The tax incentives provided by the Opportunity Zones program are based in part, on satisfying a 5 year, 7 year, and 10 year holding period. Under the rules, any QOF investments made after Dec. 31, 2019 are not eligible for the additional 5 percent capital gain exclusion since the investment will not be held for 7 years by Dec. 31, 2026.
Likewise, any QOF investments made after Dec. 31, 2021 are not eligible for the 10 percent capital gain exclusion since the investment will not be held for 5 years by Dec. 31, 2026.
Otherwise, taxpayers can obtain capital gains tax deferral by making a QOF investment at any time before Dec. 31, 2026. On Dec. 31, 2026, the lesser of the fair market value of the QOF investment or the deferred capital gain, reduced by the tax basis in the QOF investment, is recognized. Taxpayers will need to plan accordingly for this tax payment.
Taxpayers can continue to hold their QOF investment after Dec. 31, 2026 (and through Dec. 31, 2047). Under the rules, gain on the sale of the QOF investment after 10 years is excluded from federal taxable income and potentially state taxable income.
Freed Maxick Provides Opportunity Zone Consulting
If you own appreciated assets that would result in a capital gain upon sale or exchange with an unrelated person, then you may be a candidate for a QOF investment. The Opportunity Zones program experts at Freed Maxick can assist in comparing a fully taxed investment to a QOF investment.
In addition, a proposed Opportunity Zone business or real estate development project should consider the other Federal, State and Local tax credit and incentive programs that are available. Consultation with professional tax advisors knowledgeable in these programs could significantly increase the return on investment.
Freed Maxick provides advisory, tax planning and reporting services for both investors and fund sponsors considering involvement in the Opportunity Zone program, Click on the image to schedule a complementary Tax Situation Review, or contact Don Warrant, CPA at 716-332-2647 for consultation regarding the Opportunity Zones program.View full article