One of the more interesting and useful items to come out of the Tax Cut and Jobs Act of 2018 are the creation of so-called Opportunity Zones. An Opportunity Zone is a particular census tract which the government has designated as a distressed community, and investments in same are entitled to certain benefits vis a vis the investor’s capital gains taxes from such investment. The goal is to stimulate investments into such areas which would not otherwise have occurred.
The benefits that Opportunity Zones provides are related solely to the timing and possible reduction of an investor’s capital gains taxes. The program won’t apply to ordinary income tax issues, and there are no credits or other type of incentives provided for in the program (its less exciting than some folks originally thought but still a large benefit to the right investors/projects/companies though). The Opportunity Zones program provides for a delay, reduction or elimination of capital gains taxes in three ways as set forth below:
- First is a temporary tax deferral for any taxpayer who has capital gains but re-invests same, within 180 day time period, into an Qualified Opportunity Fund (discussed below). The gain is deferred but must be recognized on the earlier of the date on which the opportunity zone investment is sold or December 31, 2026 (there is some grey area with respect to holding the investment past December 31, 2026 and hopefully the IRS clears it up). You do not have to live or work in an opportunity zone, you just have to invest in it (in a company located in one or property located in one). IRS came out with this form for these re-investments – Form 8949
- Second is a step-up in basis for any capital gains that were invested (i.e. re-invested) in an Qualified Opportunity Fund. The basis of the original investment is increased by 10% if the investment in the Qualified Opportunity Zone Fund is held by the taxpayer for at least 5 years, and by an additional 5% if held for at least 7 years, excluding up to 15% of the original gain from taxation.
- Third is a total exclusion (i.e. the investor’s basis is increased to FMV) from taxable income of capital gains from the sale or exchange of an investment (but not the original capital gain which is handled by the second point above) in a Qualified Opportunity Zone Fund if held for more than 10 years.
The Opportunity Zone program allows funds to be set up, called Qualified Opportunity Zone Funds, which funds pool investor money (as a partnership or corporation) for investing in eligible property located in a Qualified Opportunity Zone (a list of such Qualified Opportunity Zones are set out in IRS Notice 2018-48 – https://www.irs.gov/pub/irs-drop/n-18-48.pdf )
To become a Qualified Opportunity Zone Fund, an eligible corporation or partnership self-certifies by filing Form 8996, Qualified Opportunity Fund, with its federal income tax return. Early-release drafts of the form and instructions are posted, with final versions expected in December. The return with Form 8996 must be filed timely, taking extensions into account.