Proposed Regulations for Opportunity Zone Incentive Program Released

A tax incentive for those who invest in designated Opportunity Zones is not an entirely new concept; states have been using similar incentives for years as a way to boost local economies. However, until recently, there had not been a Federal incentive of the type. President Trump passed the first Federal Qualified Opportunity Zone (QOZ) tax credit as part of the Tax Cuts and Jobs Act (TCJA) in December of 2017. This incentive was a last-minute measure added to the legislation, and it is often left out of the conversation when discussing the TCJA. However, QOZs provide investors tax-saving advantages that we should not overlook. Recently, the IRS released proposed regulations clarifying details of the incentive program, and these regulations can help make taxpayers comfortable with their investment decisions.

Program’s Purpose

Opportunity Zone incentives are employed to help boost the economies of certain economically-depressed areas. Under this new Federal program, states select communities to be considered for this program, and the IRS works with the Community Development Financial Institution Fund to make the final designations. Tax incentives are provided to those who invest in property that is located in these QOZs.

Proposed Regulations – Qualifying Opportunity Funds

On October 19, the IRS released proposed regulations about the QOZ tax incentive. It clarified the ways an entity can be designated as a Qualified Opportunity Fund (QOF).

As discussed in our initial QOZ article, to take advantage of the QOZ tax credits, taxpayers must first form (or join) a QOF. A QOF is an entity organized as a corporation or a partnership that invests at least 90% of its assets into QOZs. These assets must be used in the entity’s trade or business, and the first use of those assets must commence with the QOF. If the property invested is already in use by the QOF, the entity must make substantial improvements before it becomes qualifying property.

The 90% investment threshold is calculated as an average of two numbers:

1. The percentage of qualified assets on the last day of the first six month period of the entity’s taxable year; and,
2. The percentage of qualified assets on the last day of the entity’s taxable year.

If this average exceeds 90%, the entity is considered a QOF.

The regulations provided an additional option for an entity to be considered a QOF: if the entity invests in a qualified opportunity zone business (QOZ business). A QOZ business is one where “substantially all” of its assets are QOZ property. For purposes of this determination, “substantially all” equates to 70% of all tangible business property. In other words, a portion of the QOF’s 90% investment threshold can be made in a QOZ business and still allow the entity to qualify for the tax incentive as long as the QOZ business holds 70% of its tangible assets in one or more of the designated opportunity zones.

Proposed Regulations – Others

The proposed regulations also clarified the following:

• The capital gain cannot be as a result of a transaction with a related person.
• Almost all capital gains will qualify for the deferral. Ordinary gains will not qualify.
• The QOF partnership itself can elect into the tax deferral as an entity, otherwise, the individual partners can make the election for their share of the gain. Similar treatment is granted for other pass-through entities.
• When determining whether the QOF substantially improves invested property, the IRS will look to the building and disregard the underlying land.
• A taxpayer who appropriately utilized the QOZ program to defer gain may be able to dispose of their QOF investment and still defer their gain as long as they reinvest those amounts into another QOF.
• If a partnership chooses not to elect to defer their capital gain under the QOZ rules, the partners may elect to defer such gains themselves. For partners in this situation, the 180-day period in which they must reinvest their gains in a QOF begins on the last day of the partnership’s taxable year. Specifically, the clock begins on the date when the gain would be recognized for Federal income tax purposes.

Contact Us

Unfortunately, proposed regulations are just that – proposed. They cannot be fully relied upon when making investment decisions but offer insight into how the IRS views the tax law. This information can help you weigh the risks of fully adopting this tax strategy before final guidance is issued. If you have questions about Opportunity Zones or whether it’s a good tax planning move, Wilson Lewis can help! For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.