What is an Opportunity Zone?

According to the IRS, An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.

How were Opportunity Zones created?

Opportunity Zones were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017.

Have Opportunity Zones been around a long time?

No, they are new. The first set of Opportunity Zones, covering parts of 18 states, were designated on April 9, 2018. Opportunity Zones have now been designated covering parts of all 50 states, the District of Columbia and five U.S. territories.

What is the purpose of Opportunity Zones?

Opportunity Zones are an economic development tool—that is, they are designed to spur economic development and job creation in distressed communities.

How do Opportunity Zones spur economic development?

Opportunity Zones are designed to spur economic development by providing tax benefits to investors. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.

What is a Qualified Opportunity Fund?

A Qualified Opportunity Fund is an investment vehicle that is set up as either a partnership or corporation for investing in eligible property that is located in a Qualified Opportunity Zone.

When do Opportunity Zones Expire?

Though Opportunity Zone designations expire at the end of 2028, investors can keep their investments in funds through December 31, 2047 without losing any of the tax benefits, even if the zone loses its eligibility in the interim.

How is “Substantial Improvement” to a building defined?

• A substantial improvement to the building is measured by the QOF’s additions to the adjusted basis of the building (excluding the land).
• The QOF is not required to separately substantially improve the land upon which the building is located.
• to ‘‘substantially improve’’ a property, an O Fund (or subsidiary) must make additions to basis with respect to such property during a 30-month period in the hands of the O Fund (or subsidiary) that exceed the basis at the beginning of the 30-month period.

How are roll-over Capital Gains of partnerships or other pass through entities treated?

A partnership may elect to defer all (or part) of a capital gain. If an election is made, the elected deferred gain is not included in the distributive shares of the partners. If the partnership does not elect to defer gain, a partner generally may elect its own deferral with respect to the partner’s distributive share. The partner’s 180-day period generally begins on the last day of the partnership’s taxable year.

Where can I find the IRS proposed regulations from October 2019?

• https://www.irs.gov/pub/irs-drop/reg-115420-18.pdf
• https://www.irs.gov/pub/irs-drop/rr-18-29.pdf

What is the Qualified Opportunity Zone Program (“QOZ Program”)?

The QOZ Program was created by the Tax Cuts and Jobs Act of 2017. The program is intended to encourage long-term investment in low-income communities primarily through tax incentives related to qualifying capital gains.

What is a Qualified Opportunity Zone (“QOZ”)?

A QOZ is a designated census tract in the United States that has been selected by a state governor and certified by the U.S. Department of Treasury for inclusion in the QOZ Program. Governors were allowed to nominate up to 25% of their total low-income communities (“LICs”) for certification by the Treasury as QOZs. An LIC is a census tract that meets one of the following qualifications: -The poverty rate for the LIC is at least 20% -If the LIC is located in a metropolitan area, the median household income does not exceed 80% of the median household income for that metropolitan area (or the statewide median household income, whichever is greater) -If the LIC is not located in a metropolitan area, the median income does not exceed 80% of the statewide median household income

Where are QOZs located and how many are there?

There are over 8,700 QOZs spread across all 50 states, D.C., and several U.S. territories. There are rural, suburban and urban QOZs. According to ESRI1, 18.2% of the U.S. total land area is in a QOZ and 5.4% of major metro land area.

What is a Qualified Opportunity Zone Business? (“QOZB”)?

A QOZB is a business in which at least 70% of tangible assets qualify as QOZ business property owned or located in a QOZ. At least 50% of the gross income earned by the business must be from the active conduct of the business in the QOZ and generally may not be a “Sin Business.” No more than 5% of the assets of the QOZB can be “non-qualified financial property”, which generally refers to debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, etc. that do not relate to the OZ investment.

What are the potential tax benefits related to an investment in a Qualified Opportunity Fund?

There are three potential QOZ tax benefits: Deferral, Reduction, and Elimination. Deferral
The most immediate QOZ tax benefit is the ability to defer the recognition of capital gains invested in a QOF as taxable income until the QOF investment is sold or December 31, 2026, whichever occurs first. Note: There is no limit on the amount of gains that can be deferred in this manner. Reduction
Capital gains taxes may be reduced through a step-up in basis. Investors who hold their QOF investment receive a 10% step-up2 in basis for investments made before December 31, 2021 and held until December 31, 2026. Elimination3
Investors who hold their investment for at least ten years pay no tax on the appreciation of their QOF investment upon disposition of such QOF investment, regardless of the size of the potential profit. All investments involve risk and the realization of the benefits is dependent on proper structuring and the structure and performance of the future investments selected. Not all investments will provide all of these benefits.

What proceeds are eligible for QOZ tax benefits?

A capital gain is eligible for deferral if it is from the sale or exchange of property with an unrelated party (not more than 20 percent common ownership) and the gain is treated as a capital gain (short-term or long-term) for federal income tax purposes. In order to qualify for QOZ tax treatment, such gain must be invested into a QOF within 180 days of recognizing the gain (note: the deadline for investment has been extended for some taxpayers due to COVID-19; see answer to question: “Has the federal government extended the timeline for QOZ investment in response to COVID-19?”.) Gains from a wide range of investment assets are eligible, including gains from:

• Stocks, bonds, options, hedge funds
• Primary and secondary residences
• Businesses, machinery, commercial buildings, rental properties
• Land, livestock, art, wine, automobiles

What is an eligible taxpayer?

QOZ regulations provide that taxpayers eligible to elect gain deferral include:

• Individuals
• C Corporations (including regulated investment companies (RICs) and real estate investment trusts (REITs))
• Partnerships
• Certain other pass-through entities

Has the federal government extended the timeline for QOF investment in response to COVID-19?

On January 19, 2021, the federal government released IRS Notice 2021-10, providing additional relief for taxpayers affected by the COVID-19 pandemic. The notice extends the deadline for completing an investment in a QOF to March 31, 2021 for any investor whose 180-day investment period would have ended on or after April 1, 2020 and before March 31, 2021. This means that any type of capital gain, short or long-term, realized on or after October 4, 2019 is still eligible for the tax benefits related to the QOZ Program until at least March 31, 2021. There is additional flexibility for K-1 partnership gains and Section 1231 property gains realized on or after January 1, 2019.

Do QOZ tax benefits apply to states as well?

While residents of all U.S. states are eligible to receive federal tax incentives related to QOZ legislation, individual states have full discretion regarding whether or not to offer any benefits related to state taxes. Therefore, state tax treatment related to QOF investment differs from state to state.

What are the most important deadlines and/or timelines for QOF investment?

Key dates and timelines for investors are as follows:

• 180 Days: Generally, a taxpayer has 180 days from recognizing a capital gain to invest in a QOF to qualify for tax incentives. Also, the federal government has temporarily extended the deadline for investment for some taxpayers to March 31, 2021; see answer to question: “Has the federal government extended the timeline for QOF investment in response to COVID-19?”
• 5 years: If the investment is held for at least five years prior to December 31, 2026, the investor receives a step up in basis equal to 10% of the original gain amount invested in the QOF reducing the capital gain amount on which taxes are owed
• 10 years: The investor must hold the interest in the QOF for at least 10 years to qualify for elimination of taxation on gains related to appreciation of the investment
• March 31, 2021: In response to the COVID-19 pandemic, the federal government has extended the deadline for investment into a QOF to at least March 31, 2021 for any taxpayer whose 180-day investment window would have ended on or after April 1, 2020 and before March 31, 2021
• Dec 31, 2021: The taxpayer must invest in a QOF by this date to qualify for a step up in basis equal to 10% of the original gain amount invested in the QOF

Can an investor trade interest in one QOF for another?

Yes, an investor may exchange an interest in one QOF for an interest in another QOF without triggering an early recognition of capital gains tax liability, as long as the exchange is completed within 180 days.

Are gains from life insurance and annuities eligible for QOZ tax treatment?

No. Because gains from life insurance and annuities are taxed at normal income tax rates (not at the capital gains tax rate), they are not eligible for QOZ tax treatment.

Can an investor invest “non-qualified” proceeds into a QOF?

Yes. Any proceeds may be invested into a QOF, but only eligible gains can receive the QOZ tax benefits.