What’s New for Opportunity Zone Investors in 2019? by Arkadiy (Eric) Green, CPA
Posted on May 14, 2019
The IRS recently issued a highly expected, second set of proposed regulations on the Opportunity Zone program intended to help more investors, developers, business owners and underserved communities across the U.S. begin working together to maximize the intended benefits of this program.
Congress established the Opportunity Zone program at the end of 2017, as part of the Tax Cuts and Jobs Act (TCJA), with the purpose of encouraging investment, economic growth and job creation in designated distressed communities (qualified opportunity zones) by providing federal tax incentives to taxpayers who invest in businesses located within these communities. The IRS issued a first set of proposed regulations on Opportunity Zones in October of 2018; however, these regulations left many unanswered questions and considerable uncertainty regarding many aspects of the program. A second set of proposed regulations provide many additional answers and deliver some much-needed clarity to investors.
What Are The Tax Benefits of the Opportunity Zone Program?
The Opportunity Zone program offers investors the potential ability to defer, reduce or even eliminate taxes on certain capital gains generated from the sale of appreciated assets, including real estate, stocks, bonds and other investment type property. To qualify for preferential tax treatment, investors generally have 180 days from the date on which the gain would be recognized to roll over a gain into a qualified Opportunity Fund (QOF) created specifically to invest in real estate projects and/or businesses located in any of the more than 8,700 distressed, low-income communities that the federal government has certified as qualifying Opportunity Zones (QOZs). The longer the taxpayer holds his or her investment in the QOF, the greater the tax benefit.
Taxpayers that reinvest capital gains into a QOF may defer paying tax on that amount until the earlier of Dec. 31, 2026, or the date they sell an interest in the QOF. If they hold the QOF investment for at least five years, they can receive a 10 percent step-up in the basis on the original investment and be able to exclude 10 percent of the rolled over gain from taxes. Investments held for at least seven years avoid taxes on 15 percent of the original deferred gain. Should investors keep their qualifying investment in a QOF for at least 10 years, they have an opportunity to completely avoid paying tax on post-acquisition appreciation of their investment in QOF.
What Does the April 2019 Opportunity Zone Guidance Cover?
The long-awaited regulations issued by the IRS on April 17, 2019, clarify many issues that are not addressed in the original language of the statute or the initial IRS guidance issued in October 2018. Taxpayers should meet with experienced advisors and accountants to understand how these provisions affect their unique facts and circumstances, and how they may fit into a larger strategy for preserving wealth and maintaining tax efficiency.
Among many other things, the regulations address the following issues:
- Allow taxpayers to contribute cash and/or other property in a QOF partnership in exchange for a qualifying investment;
- Clarify that only net Section 1231 gains are eligible for deferral, with the 180-day period beginning on the last day of the tax year;
- Debt-financed distributions – subject to certain limitations, allow debt-financed distributions from a QOF partnership to investors without triggering gain inclusion.
- Investment in operating businesses – provide helpful working capital safe harbor and income sourcing rules;
- Treatment of leased property – clarify that, subject to certain rules, leased property can be treated as qualified opportunity zone business property (QOZBP);
- Clarify original use and substantial improvement requirements for unimproved land and buildings that have been vacant for five years;
- Sale of assets before 10-year holding period – provide 12-month period for a QOF to reinvest the proceeds;
- Carried interests – clarify that carried interests are generally treated as a non-qualifying investment (i.e., not eligible for OZ program benefits);
- Exit rules – allow investors who have held the QOF interest for at least 10 years to elect to exclude from income flow-through capital gains attributable to the QOF’s sale of qualified opportunity zone property (QOZP);
- Exiting QOZ investment;
- Reinvesting gains;
- Defining qualified opportunity zone businesses (QOZBs) and qualified opportunity zone business (QOZB) property;
- Satisfying the income and working capital tests;
- Treatment of leased property; and
- Treatment of transfers of ownership interest by gift and at death.
About the Author: Arkadiy (Eric) Green, CPA, is a director of Tax Services with Berkowitz Pollack Brant, where he works with real estate companies, commercial and residential developers, property management companies, real estate investors and high-net-worth individuals to structure investments and complex transactions for maximum tax efficiency. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.