Opportunity Zones: Frequently Asked Questions Part 1
posted Apr 25, 2019 by Joe Tamburo, CPA in the Global Tax Blog
Have you invested in Opportunity Zones (OZs) yet? OZs are a new community development program established by Congress in the Tax Cuts and Jobs Act of 2017, to encourage long-term investments in low-income urban and rural communities nationwide. Here are a few key points.
Q: Where are the zones located?
A: There are over 8,700 OZs which can be found here: https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx
Q: What are the basic benefits of investing in an opportunity zone?
A: There are 3 main benefits.
- Capital gain deferral. Instead of paying tax on 2019 capital gains next April with their return, they can pay the tax at the earlier of the date they sell their investment or December 31, 2026.
- Partial reduction of the gain that has been deferred. A taxpayer could receive up to a 15% benefit depending on how long they hold their investment in an OZ Fund.
- The exclusion of additional gain on the appreciation in their investment in the Qualified Opportunity Fund (QOF).
Q: What is a Qualified Opportunity Fund (QOF)?
A: A QOF is the intermediary between the investor and the actual investments in the opportunity zones. A QOF may be set up as either a partnership or a corporation which must invest in “qualified opportunity zone property”. The fund must hold at least 90% of its assets in “qualified opportunity zone property”
Q: How does the gain deferral/gain reduction work?
A: In order to qualify for the gain deferral, investors must invest their capital gains in the QOF within 180 days of receiving those gains. A taxpayer will then have an initial basis in their investment of $0.
- If they hold their investment in the QOF for at least 5 years they will have their basis increased by 10% of the deferred gain amount.
- If they hold their investment for 7 years they will have their basis increased an additional 5%.
Thus if the investment is held for at least 7 years, the taxpayer would only be paying 85% of the original gain amount.
Q. How does the permanent exclusion of additional gain work?
A: If a taxpayer holds their interest in a QOF for 10 years they can elect to step-up their basis in the investment to fair market value (FMV) of that interest on the date of the sale/exchange. That allows there to be no gain on the appreciation above the initial investment. For example, let’s say you deferred and invested $1,000,000 of capital gain which was then sold after 10 years for its fair market value at the time of $2,000,000. You would not have to pay capital gains tax on that $1,000,000 of appreciation.
Q. Who can use this tax benefit?
A: Gains that are realized by individuals, corporations, S-Corporations, partnerships, trusts & estates qualify for all of the opportunity zone tax benefits. The gain must be a capital gain, not derived from a sale with a related party and recognized for federal taxes before 1/1/2027.
Q: How does the election work for a pass-through entity and its partners/shareholders?
A: If a pass through entity has an eligible gain it has a decision to make. It can defer all or a portion of the eligible gain into an opportunity zone fund. The amount of the gain that is deferred is not allocated to the partners/shareholders. However, if the entity does not elect to defer the gain, it will pass through to the partners/shareholders. They can then make their own decision regarding investment into a QOF to defer their gain and enjoy the other benefits of Opportunity Zones.
Check out part 2 of our Opportunity Zone FAQs where we cover more on the 90% requirement, establishing a qualified opportunity zone fund, and more.
Questions? Contact us.