In an effort to prompt investments, increase jobs, and reduce poverty in some of America’s most economically distressed communities, Congress provided a tax incentive for investors to receive preferential tax treatment, while investing in areas designated as Opportunity Zones. Opportunity Zones were added to the tax code by the Tax Cuts and Jobs Act (“TCJA”) on December 22, 2017. The program will allow investors who invest in a Qualified Opportunity Fund (“QOF”) to defer tax on capital gains that have been invested in the fund. The IRS has recently released proposed regulations that provide guidelines and qualifications for the tax incentive. This article is designed to provide a brief overview and highlights of the program.
What is an Opportunity Zone and a Qualified Opportunity Fund?
Opportunity Zones are an economic development tool that is designed to stimulate economic growth and job creation in communities that are considered to be economically distressed. These areas are population census tracts that are considered to be “low-income” communities, and are designated as Qualified Opportunity Zones (“QOZ”). A Qualified Opportunity Fund (“QOF”) is an investment vehicle that is set up as either a partnership, corporation, or a LLC that elects to be treated as either a partnership or corporation, for investing in eligible property that is located in a QOZ. The QOF is required to hold at least 90% of its assets in Qualified Opportunity Zone Property.
You can access the map of the opportunity zones in Florida at:
What are the Tax Benefits?
The tax benefits are essentially a temporary (immediate) tax deferral in the current tax year; permanent exclusion of a portion of the deferred gain (for investment interests that are held for 5 or 7 years); and permanent exclusion of the post-acquisition appreciation in the investment, if the investment interest is held for 10 years.
How Does it Work?
If an investor realizes a gain from the sale or exchange of a capital asset to an unrelated party, the investor will have 180 days from the date of the sale or exchange to reinvest the gain amount with a cash investment into a QOF (defined above). Only the gain must be invested, not all of the proceeds from the sale. When the investor invests in the QOF, the investor will receive either stock or an interest in the QOF, and the initial basis in the investment will be zero. If the investor holds the interest for a certain period of time, based on the earlier of the date that the property was sold, or December 31, 2026, the investor will receive the following preferential tax treatment:
– If the investment interest is held for at least 5 years, there is a 10% exclusion of the deferred gain from income, based on the amount that the investor originally elected to defer. In other words, the investor’s basis in the QOF will increase in an amount equal to 10% of the original investment amount. The Investor would only recognize and pay tax on 90% of the gain that was originally deferred.
– If the investment interest is held for at least 7 years, there is a 15% exclusion from income of the deferred capital gains, based on the amount that the investor originally elected to defer.
– If the investment interest is held for at least 10 years, then the investor can elect to have a basis that is equal to the fair market value (“FMV”) on the date that the investment is sold or exchanged. In other words, the post-acquisition gain would be permanently excluded from income.
What type of gains qualify?
According to the proposed regulations, any gain that is treated as capital gain for Federal income tax purposes is eligible for deferral through investment in a QOF. This includes short-term, long-term, ordinary or Section 1231 (gain from the sale of business property).
Qualifications to become a QOF:
To become a QOF, an eligible corporation or partnership must certify to the IRS that it is a QOF by completing and attaching a required form to their income tax return. The QOF is required to hold at least 90% of its assets, real and tangible property, in Qualified Opportunity Zone Property; the property must be acquired after December 31, 2017 by the QOF; and the use of the property must be originated or substantially improved by the QOF.
In 2018, Ivan Investor sold stock, and made a $300,000 profit on the sale. Ivan decides to invest the gain in a QOF. The QOF then invests in property located in an opportunity zone. Ivan gets an immediate deferral of gain on his current year’s tax return. If Ivan holds his interest in the QOF for 5 years, then sells or exchanges the property, he can exclude 10% of the deferred gain from income, which is $30,000. If Ivan held his interest for 7 years, then he could exclude 15% of the deferred gain from income, which is $45,000.
This article is intended to give a brief overview and highlights of the Opportunity Zone Program, and the tax incentives offered. If you, or your client, would like more information, or assistance in creating a QOF, please contact us at (941) 954-9991. Please also visit our website, berlinpatten.com, for more information on Opportunity Zones.