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Tax Incentives for Investment in Opportunity Zone Property

What are Opportunity Zones?

The concept of an "opportunity zone" was added to the tax Code by the 2017 tax act. An opportunity zone is a population census tract that meets the definition of a "low-income community" (as that term is defined under §45D(e) in the context of the New Markets Tax Credit) and has been specifically designated as a qualified opportunity zone (QOZ) under §1400Z-1. IRS Notice 2018-48, (July 9, 2018) includes an official list of all population census tract designated as QOZs. There are now over 8,700 certified QOZs in all 50 states, the District of Columbia, Puerto Rico and the Virgin Islands.

The designation of a census tract as a qualified opportunity zone remains in effect for the period of time beginning on the date of that designation and ending on December 31st of the 10th calendar year beginning on or after the date of designation (i.e., December 31, 2018).

Congress refers to the opportunity zones program as an economic development tool. That is, the designation of these low-income communities as QOZs in intended to incentivize the movement of capital into these designated areas to develop property and create and expand businesses in an effort to reduce poverty and increase employment.

 The incentive is accomplished by offering taxpayers who invest in these QOZs (through specific investment vehicles referred to as Qualified Opportunity Funds) and hold the investment for certain prescribed periods of time significant benefits including gain deferral, forgiveness of a portion of the deferred gain and exclusion from gain for post-acquisition appreciation in the investment.

What are the Tax Incentives for Investment in an Opportunity Zone?

Pursuant to this new tax incentive, if a taxpayer (1) realizes gain from the sale to, or exchange with, an unrelated person of any property held by the taxpayer, and (2) invests all or a portion of that realized gain into a "qualified opportunity fund" (QOF) within 180 days of the realization event, the taxpayer is able to elect to defer the invested gain until the earlier of (a) the date that the taxpayer sells or exchanges the investment in the QOF or (b) December 31st, 2026, at which point the taxpayer recognizes the lesser of (a) the fair market value of the investment over basis or (b) the deferred gain over basis. Thus, the latest that the deferred gain is required to be recognized is December 31, 2026.

In addition, the following special rules apply:

  • The taxpayer's initial basis in the investment in the QOF is zero.
  • If the taxpayer holds the investment in the QOF for at least 5 years, the taxpayer's basis in the investment is increased by an amount equal to 10% of the gain that the taxpayer originally elected to invest and defer (which means that 10% of the deferred gain is permanently excluded).
  • If the taxpayer holds the investment in the QOF for at least 7 years, the taxpayer's basis in the investment if further increased by an amount equal to 5% of the gain that the taxpayer originally elected to invest and defer (which means that 15% of the deferred gain is permanently excluded).
  • If the taxpayer holds the investment in the QOF for at least 10 years, the taxpayer can elect to have the basis equal fair market value on the date the investment is sold or exchanged (which means that post-acquisition gain is permanently excluded).

Note that there are essentially 3 separate tax benefits - (1) temporary deferral; (2) permanent exclusion of a portion of the deferred gain (for investments held 5 or 7 years); (3) permanent exclusion of post-acquisition.

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