If you or your companies or clients are holding appreciated property of any kind, whether in the form of investments like stock, bonds, or a passive investment in a pass-through entity, or in the form of vacant land or a commercial or residential building, or other capital assets, there is a new opportunity to sell the property and defer and reduce the capital gain, while investing in a new business or property that could potentially be sold tax-free.
The Federal tax reform bill enacted earlier this year contains a new tax incentive aimed at directing capital and investment into America’s distressed areas. The new program is called the Opportunity Zone program.
The Opportunity Zone program affords any taxpayer who has or will have capital gains from the sale or disposition of any property, the ability to defer and reduce the gain from the sale if the gain is reinvested in a Qualified Opportunity Fund within 180 days of the sale. The deferral lasts until the earlier of the following two dates: the date on which the Qualified Opportunity Fund investment is sold; or December 31, 2026. Importantly, this deferral mechanism can be used to transform short-term gains, which would be taxed as ordinary income, into long-term capital gains taxed at preferential rates.
In addition to deferring the gain from the sale of property, the Opportunity Zone program also provides a reduction of the gain if the Qualified Opportunity Fund investment is held by the investor for a minimum of 5 years. If the investor holds the Qualified Opportunity Fund investment for at least 5 years, its original deferred gain is reduced by 10 percent. If the Qualified Opportunity Fund investment is held for at least 7 years, the original deferred gain is reduced by 15 percent. (The reductions to gain are accomplished by increasing the basis of the Qualified Opportunity Fund investment which begins at zero and is used for computing both the original gain that is deferred and recognized, as well as the new gain on the sale of the Qualified Opportunity Fund investment.)
Accordingly, taxpayers investing in Qualified Opportunity Funds can defer and potentially reduce capital gains from the sale of any property or assets by rolling those original capital gains into a Qualified Opportunity Fund.
Finally, there is one last, but very significant tax benefit for investing capital gains in a Qualified Opportunity Fund. If a taxpayer holds the Qualified Opportunity Fund investment for at least 10 years, the taxpayer’s basis in the Qualified Opportunity Fund investment is increased to fair market value. The result is no recognition of gain from the sale of a Qualified Opportunity Fund investment held for at least 10 years.
At this point you may be thinking this is too good to be true. You may also be wondering what in the world a Qualified Opportunity Fund is and whether you could even form or identify one for investment to take advantage of this new tax benefit.
First, in order to take advantage of this program, the sale of any property giving rise to the gain to be invested in a Qualified Opportunity Fund must take place on or before December 31, 2026. Furthermore, a Qualified Opportunity Fund can be any corporation or partnership organized for the purpose of investing in Qualified Opportunity Zone Property, which is defined to include: stock or partnership interests in businesses based in an Opportunity Zone and acquired after Dec. 31, 2017; or tangible property and buildings used in a trade or business of the Qualified Opportunity Fund if acquired after Dec. 31, 2017 and the original use of the property is in the Opportunity Zone or it has been substantially improved. Substantial improvement is defined to mean if during any 30-month period following acquisition, the additions to basis via improvements made to the property equal the adjusted basis of property at the beginning of the 30-month period.
According to recent Internal Revenue Service (“IRS”) guidance, the creation of a Qualified Opportunity Fund is expected to be via a self-certification process through a form expected to be available later this summer. Additionally, funds may be created by any taxpayer for single or multiple investments.
A Qualified Opportunity Fund must maintain at least 90 percent of its assets in Qualified Opportunity Zone Property, which may include stock, partnership interests, business property and buildings, as discussed above. The IRS is expected to issue regulations which would afford a Qualified Opportunity Fund the ability to sell or transfer Qualified Opportunity Zone Property if the proceeds are reinvested in other Qualified Opportunity Zone Property without triggering a taxable event. In addition, an asset test is employed at the end of the first 6 month-period and at the end of the taxable year to ensure the fund meets the 90 percent limitation. If a fund fails the asset test without reasonable cause, penalties may be imposed.
Now that you have an understanding of what a Qualified Opportunity Fund is and how to properly invest in one to secure the tax benefits outlined above, the next and final piece for understanding the new program is identifying where the Opportunity Zones are based across the country.
- Click here for a list of opportunity zones.
- Click here for an interactive map for identifying the zones.
(After you click the link taking you to the interactive map, click the layers tab on the right and unselect the entry for “2011-2015 LIC Census Tracts.” Then if you use the map’s zooming tool, the Opportunity Zones are shaded in each state.)
The Opportunity Zone program has the potential to unlock billions in gains and capital for investment in the zones. It has often been described as a “Super 1031” with a tax reduction bonus and ability to avoid any tax on the appreciation of a real estate project or business based in the zone. Don’t miss out on the opportunity to take advantage of this amazing opportunity.
Please click here for a summary power point presentation we prepared on the basics and benefits of the program, including examples.
We will continue to keep you updated as more details emerge on this transformative program, including expected guidance from the IRS and new regulations.