The Tax Cuts and Jobs Act of 2017 introduced Opportunity Zones (OZs), a new community reinvestment tool designed to use tax incentives to promote long-term investment in qualifying urban and rural communities. Since then, the IRS has identified 8,700 Qualified Opportunity Zones (QOZs) in the United States, the U.S. Virgin Islands and Puerto Rico. This broad legislation is anticipated to benefit many stakeholders including individual taxpayers, developers, businesses, lenders, investors, fund sponsors and the impacted communities.
Thompson Hine has created a multidisciplinary team including lawyers from our Tax, Real Estate, Construction, Finance and Corporate practice groups, as well as professionals from our subsidiary, Project Management Consultants, who have considerable experience advising on incentives. This team collaborates to stay abreast of QOZ regulations and revenue rulings, prepares comments to the IRS and to Ohio officials with respect to pending state tax enhanced benefits to best promote our clients’ interests, and works closely with clients to determine how best to incorporate QOZ strategies into their business plans.
This multidisciplinary team guides our clients on planning and executing investments in businesses and properties located in QOZs and on the organization of and investment in Qualified Opportunity Funds (QOFs), through which the project level investments will occur. Our team provides legal analysis of how rules and regulations apply to specific investments in projects across the country and client objectives.
Congress established OZs in the Tax Cuts and Jobs Act of 2017. Eligible census tracts were defined by the law and a process was devised for nomination and approval in early 2018. Across the country, 8,700 QOZs have been identified as the final tracts for the program. At this time, there are no provisions to add additional eligible census tracts. A mapping tool is available to see the QOZs and determine if an address is in a QOZ.
A QOF is any investment vehicle organized as a corporation or partnership (including a multi-member LLC) with the purpose of investing in QOZ Property. Any individual or entity with capital gains may invest them within 180 days of realizing the gains. The capital gains must be from a transaction with an unrelated party, as defined for QOZs, and can include capital gains from the sale of stock, personal property or real estate (but excluding depreciation recapture taxed as ordinary income).
Taxes on the capital gains that are invested in a QOF are deferred until the earlier of the disposition of the investment in the QOF or December 31, 2026, with 10% and 5% increases at the five- and seven-year marks, respectively (resulting in up to 15% exclusion of deferred capital gains). Gains from the sale of an investment in a QOF (but not the deferred capital gains) held for at least 10 years will not be subject to federal income tax.
The capital gains cash amount must be invested in one or more QOFs through an equity interest issued by the QOF, whether common or preferred shares or a partnership interest with special allocations. An investor cannot purchase an outstanding interest in a QOF as a qualifying interest.
The QOF must invest the capital gains amount in QOZ Property, which may be a QOZ equity interest or a QOZ Business Property (QOZ Property).
QOZ Equity Interest
Examples of QOZ equity interests include interests in partnerships or multi-member LLCs, or stock in C or S corporations, that meet these requirements:
QOZ Business Property
QOZ Business Property is tangible property used (through ownership or lease) in a QOZ Business that meets the following requirements:
A QOZ Business is an active trade or business that meets the following requirements:
Important note: The instructions to IRS Form 8996 (used to elect QOF status) state that the QOF organizing documents are to include a description of the QOZ Business that the QOF expects to engage in, either directly or indirectly through the first-tier operating entity. For structuring purposes, if the QOF has the business (rather than just an interest in a partnership or corporation), it’s important to confirm that the QOF meets the QOZ Business requirements.
An important aspect of the QOZ tax incentive is that a taxpayer with a capital gain may invest the funds in a Qualified Opportunity Fund (QOF), and as long as the QOF invests those funds in a Qualified Opportunity Zone Property (QOZP), the taxpayer may defer the tax on the gain through the earlier of the sale of the property or December 31, 2026.
Some important points for real estate investments:
The IRS has received numerous recommendations to extend the six-month period for a QOF to invest in QOZP to satisfy the 90 percent test.
The IRS is expected to issue additional regulations by March 31, 2019; however, Treasury Secretary Steve Mnuchin has indicated that the next release will provide guidance for investments in QOZ businesses.
QOZs were created by the Tax Cuts and Jobs Act of 2017 to incentivize investments in qualifying urban and rural areas. Individuals, partnerships and corporations with capital gains may deposit these funds into a QOF, which can be structured as a corporation or a partnership (or other pass-through entity) that holds at least 90% of its assets in QOZs. An investor has 180 days from the sale of an appreciable asset to invest capital gains in a QOF. The potential benefits of this investment include:
Important driver: Post-investment appreciation in value. As with any investment, an important factor with QOZs is the potential appreciation. The third tax benefit listed above is based solely on post-investment appreciation. The first two tax benefits can be valuable (provided capital gains rates do not increase to the point of cancelling out these benefits), but such benefits can be diminished if future appreciation is limited when compared to alternative non-QOZ investments. Anyone contemplating an investment in a QOZ for business expansion reasons or otherwise should consider the QOZ program, regardless of whether all tax benefits are available in full.
There are many rules and regulations that vary in accordance with the types of investments. Although to date the IRS has issued proposed regulations covering many, but not all, salient issues for investors to consider, the IRS did expressly permit taxpayers to proceed based on the proposed regulations.
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