By now, you may have heard about Opportunity Zones. Opportunity Zones were created through legislation that was passed into law in the 2018 Tax Act. We now have over 8,700 zones across the United States where development is being promoted through a tax shelter. It is anticipated that over $100 Billion dollars in private funds will be invested into these opportunity zones. Each zone was designated by each state’s governing body and then approved by the U.S. Treasury Department. Since the recent update released in April was 169 pages, we break down some keys points below.
WHAT WE ALREADY KNEW
Three Incentives to taxpayers to invest in economically distressed areas:
- Temporary Deferral: Defer capital gains tax until 2026 by investing unrealized gains in a Qualified Opportunity Fund of which is self-certified.
- Reduction of Capital Gains Tax: Tax liability cost basis is reduced by 10% if the investment is held in the fund for 5 years and an additional 5% reduction if held in the fund for 7 years.
- Exemption: If the investment is held in the fund for 10 years, the capital gains accrue tax-free
Who & How?
It is important to note that any taxpayer can elect to defer gains. Individuals, LLC’s, C-Corps, partnerships, S-Corps, trusts and estates can all elect to defer their gains by filing a Form 8949 with a tax return.
Only tax on capital gains from sale or exchange can be deferred. Ordinary gains are not eligible.
- Short-term capital gain
- Long-term capital gain
- Section 1231 gains from a sale of business assets
- Unrecaptured Section 1250 gains
- REIT and RIC capital gain dividends
- Collectible gains
- Carried interest
- Qualified Opportunity Fund
A qualified opportunity fund (QOF) is a self certified entity that owns interest in eligible property or businesses within an Opportunity Zone. 90% of the assets from the fund must be held in Opportunity Zone property which is reported on the tax return each year. Investments must be equity investments in businesses, tangible property, or real estate within an Opportunity Zone.
Opportunity Zone Investor -> Qualified Opportunity Fund -> Operating Partnership -> Qualified Opportunity Zone Business or Real Estate
- Taxpayers have 180 days from the end of the taxable year to invest the capital gain into the Opportunity Fund. For example, 180 days from December 31, 2018 is June 29th, 2019.
Qualifications of OZ Business Property
- Property within an Opportunity Zone has to be purchased after December 31, 2017.
- Land and vacant buildings are NOT required to be substantially improved after they are acquired
- Property that is straddling an Opportunity Zone has to have more than 50% of the square footage within the zone
- When exiting, proceeds from a sale or disposition of property must be reinvested within twelve months of the sale
These updates brought some much needed clarifications on many different topics within this legislation that was passed into law in the 2018 Tax Act. Please feel free to use this as a reference when making investment decisions on Qualified Opportunity Funds.
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