IRS Proposes New Regulations for Opportunity Zones
posted Jan 4, 2019 by Maurice Bortzfield in the Global Tax Blog
Looking to save tax? The Opportunity Zone tax incentives under Internal Revenue Code (IRC) 1400Z-2 are designed to encourage investment in designated underdeveloped areas throughout the country. Check out our blog, “Opportunity Zones: Invest in Your Community while Saving Tax.” There have been a few updates to opportunity zones since our last blog—we’re here to keep you up to date on this tax saving opportunity.
What tax savings are offered through opportunity zones?
1400Z-2 provides that capital gains that are reinvested into a Qualified Opportunity Fund “QOF” within 180 days from the sale allow for the deferral of capital gain recognition. The gain deferred is recognized at the earlier of when the QOF interest is sold or December 31, 2026.
If the interest in a QOF is held for at least:
- 5 years - the taxpayer excludes 10% of the gain permanently
- 7 years- the taxpayer excludes 15% of the gain permanently
- 10 years- the taxpayer’s gain from the sale or exchange of QOF interest can be permanently excluded.*
*For this exclusion the QOF cannot sell the underlying property, instead the deferral is only allowed for the sale of a QOF interest. Therefore utilizing a one property/project per QOF may allow for a simpler exit.
In addition to the benefits described, investing in QOFs allows you to take advantage of other common tax incentives such as the Low Income Housing; Historic; and Energy credits.
Proposed Regulations- October 2018
With the release of Revenue Ruling 2018-29 on October 19th, 2018 and proposed regulations posted on October 29th, 2018, guidance surrounding the Opportunity Zone tax incentives have finally begun to clarify the many lingering questions surround these incentives.
Specific areas addressed are…
The substantial improvement requirement; A QOF must make substantial improvements to the property within 30 months to qualify. Through Revenue Ruling 2018-29 and the proposed regulations, the substantial improvement test is now clarified to be a doubling of the building’s original adjusted basis. By excluding the land’s value for this test QOFs have a more favorable investment requirement especially when purchasing vacant land or properties that contain structures with negligible value.
Working capital safe harbor for the 90% asset test- Another requirement of the QOF is that it must invest at least 90% of its assets in Opportunity Zone Property. This is tested at every 6 months into the QOF’s tax year and at the end of each tax year. The proposed regulations provide a method to comply with this requirement when longer term projects call for working capital balances that may otherwise jeopardize the 90% asset test. This is accomplished by holding capital at a Qualified Opportunity Zone Business “QZOB” level for a maximum of 31 months. In addition, the QZOB must have a specific written plan that identifies the property; a written schedule for the deployment of capital correlating with the business operations; and the schedule is substantially abided by.
Under §1400Z–2(f)(1) the penalty for failing the 90% test is calculated by the amount equal to 90% of the fund’s assets, over amount of qualified opportunity zone property, multiplied by the federal underpayment rate for each month. It should be noted however that the statute describing the penalty contains a technical error in stating, “the 90-percent requirement of subsection (c)(1)” when in fact the 90-percent requirement is found within (d)(1).
- Use of leverage. The proposed regulations also clarify that using the equity interest in a QOF as collateral for a loan is permissible. In a leverage preferred real estate industry, this was very welcomed news.
Interested in investing in opportunity zones? The regulation is still very new, you’ll want to consult your tax advisor for advice.
Questions? Contact us today.