Last month on our blog, we introduced Qualified Opportunity Zones as a newer incentive to invest in distressed communities. Introduced in the Tax Cuts and Jobs Act of 2017, Opportunity Zones give businesses and individuals substantial tax savings in exchange for locating or relocating a business or investing in property in a federally designated Opportunity Zone. To do this, taxpayers must establish a Qualified Opportunity Fund (QOF), self-certify with the IRS using Form 8896, and contribute eligible investments to the QOF within 180 days of recognized capital gains. The IRS won’t respond to the election, but it will closely verify compliance each tax year that benefits are to be claimed.
A QOF needs to hold at least 90 percent of its assets in a Qualified Opportunity Zone. Assets like stocks, partnership interests, and business property (acquired or leased after 2017) qualify, and unrelated cash can be held in the QOF as well (though it wouldn’t get the preferential tax treatment). There are additional guidelines; check with your CPA for details.
Timing Matters
It makes a lot of financial sense to invest in a Qualified Opportunity Zone as a year-end tax planning strategy. Establishing a Qualified Opportunity Fund (QOF) as an investment vehicle for Opportunity Zones before the end of 2019 will ensure that taxpayers receive the maximum potential benefit. Deferred capital gains and the holding period for reduced step-up in basis will expire on December 31, 2026. To clarify, up to 15 percent of investment gains can be deducted if the investment is held for at least seven years (making 2019 the last year to qualify for the full amount), or 10 percent if the investment is held for at least five years. Therefore, to receive the lower of the reduced gain, the asset must be placed into service by the end of 2021.
Regardless of the deferred capital gains or basis step-up, if a Qualified Opportunity Fund (QOF) is held for at least ten years, the taxpayer will still be eligible for a permanent exclusion of capital gains, through 2047. Eligible capital gains include:
- Gross short- and long-term capital gains
- Net gain on section 1256 contracts (part of the IRS’s second set of proposed regulations in 2019)
- Net gains on section 1231 (part of the IRS’s second set of proposed regulations in 2019)
- Unrecaptured gains on section 1250 (part of the IRS’s second set of proposed regulations in 2019)
In addition to individuals and partnerships, QOFs can also be established by S-Corps, estates and trusts, and C-Corps, including Real Estate Investment Trusts (REITs).
Other Tax Benefits of Opportunity Zone Projects
To further encourage investments in Opportunity Zones, many states and local governments offer additional tax incentives, like:
- Property tax abatements
- Sales and use tax exemptions or refunds
- Corporate income and franchise tax credits
- Tax increment financing
- Sustainability incentives
- New market tax credits
- Low-income housing credits
In total, these incentives can usually offset project costs by as much as 10 or 15 percent. Other non-tax incentives are usually available too. Often, projects in Opportunity Zones can qualify for cash grants, expedited permitting, and assistance with various other aspects of running a business or managing real estate, like utility discounts.
Community revitalization takes many forms and Opportunity Zone projects can be much more than affordable housing or blighted areas (although those projects will certainly qualify). While the initial goals are to spur job growth, invest in new businesses, and improve distressed communities, specific investment ideas based on states’ goals for economic development include:
- Education and social infrastructure
- Maximizing opportunities near transit hubs
- Manufacturing and logistics
- Research facilities
- Healthcare
- Higher education
- Military base restoration
If you’re looking to relocate your business or set up another physical location, or you’re searching for the next big real estate project, it might be a good idea to research a Qualified Opportunity Zone. In a future post, we’ll explore what constitutes a Qualified Opportunity Zone business, and how existing property can also qualify for the tax benefits. Contact the Tax Team at Naden/Lean if you’re curious about Opportunity Zone tax benefits or other year-end tax planning questions.