Opportunity Zones Tax Incentive
The Opportunity Zones tax incentive was included as part of the federal Tax Cuts and Jobs Act of 2017 to provide developers with the opportunity to defer capital gains and help develop distressed communities through qualified opportunity zones (QOZs). Specifically, QOZs offer investors the following advantages:
- Temporary tax deferral until 2026 by rolling gains into a qualified opportunity fund (QOF). A QOF must have at least 90 percent of its assets invested in qualified opportunity zone property, which includes one of three things: qualified opportunity zone business property, QOZ stock or QOZ partnership interest.
- Step-up in basis: After five years, investors receive a basis increase of 10%; after seven years, investors receive an extra 5% basis increase for a total of 15%.
- If an investor holds their investment in a QOF for 10 years or more, the basis will be equal to the fair market value of the investment, which creates a permanent capital gain.
Investors were able to gain the full tax benefit by making investments before the end of 2019. The IRS issued final regulations on December 19, 2019, just weeks beforethe December 31, 2019 deadline. Still, there are significant tax savings for property owners who wish to take advantage of the opportunity zones tax incentive.
COVID-19 Relief for Qualified Opportunity Funds
The IRS issued Notice 2020-39 on June 4, 2020 to provide relief to QOFs, QOZ businesses and their investors. The notice extends certain deadlines and working capital suspensions due to pandemic-related interruptions that have delayed project financing, approvals and construction activities. Overall, the IRS is providing investors with greater flexibility in making QOF investments. Learn more.
Opportunity Zone Guidance
Additional guidance clarified that multi-asset fund structures would be treated favorably, and that underlying sales of assets would not trigger a capital gain for fund investors. In addition, the testing of funds for compliance was loosened (for rules around working capital and timing aspects). Treasury also clarified that partnership (LP or LLC) structures would be more favorable than REITs, and that a partnership format would be permitted to refinance properties and return capital to investors without triggering a capital gain, up to the basis in the fund.
How Do Developers Qualify for the Opportunity Zones Tax Incentive?
Based on recommendations from U.S. governors, the IRS established 8,700 approved QOZs in all 50 states, which are designated by census tracts. Once a developer has identified eligible property, the QOF can take form by following specific guidelines including entity structure, documentation, business operations, asset holdings and filing requirements, among others. Developers and business owners should work closely with their specialty tax advisors to ensure they can provide their investors with an exceptional tax-incentivized program.
Anyone with a capital gain is eligible to participate, and that gain can come from any type of property including mutual funds, private businesses, public stocks or real estate.
Opportunity Zone Regulations
The regulations for opportunity zone compliance can be complex. The following regulations provide an overview.
- At least 70% of the business-owned or leased property must be a Qualified Opportunity Zone business property;
- At least 50% of the gross income must be derived from the active conduct of the business;
- A substantial portion of the intangible property must be used in the active conduct of the business;
- Less than 5% of the average aggregate unadjusted basis of the property is attributable nonqualified financial property; and
- The business cannot be what is considered a “sin business,” which includes golf courses, country clubs, liquor stores, etc.
Below you will find a list of frequently asked questions about Opportunity Zones and other resources provided by the IRS.
FAQs: Opportunity Zone Tax Incentives
If I already own a property inside an OZ can I put it in a fund?
You can use existing entities as the QOFs, but only tangible property purchased after 2017 can qualify.
Can I sell a property that I used 1031 exchange to buy and roll all proceeds into an Opportunity Fund?
Yes. If you have a replacement property from a prior Sec. 1031 exchange and you sell it, you will trigger capital gains that could be invested and deferred/excluded under the OZ rules.
If 90% of fund dollars need to be invested, where does money for substantial improvements come from?
The tests aren't applied until the six-month mark. Also, the regulations allow the taxpayer to hold working capital for up to 31 months.
For more information, please see the IRS Opportunity Zones FAQs
Designated Opportunity Zones
The following is the complete list of all population census tracts designated as zones for purposes of §§ 1400Z-1 and 1400Z-2. The Internal Revenue Service will be governed by this list in administering § 1400Z-2.
CDFI Fund Interactive Map
See the CDFI Fund Interactive Map of designated Opportunity Zones throughout the United States. The map allows you to layer by census tract, congressional district, county and more.
To learn more about how ETS can assist you with taking advantage of the Opportunity Zones tax incentive, please complete the form below or contact us at (800) 236-6519.