The “Tax Cut and Jobs Act” passed in late 2017 includes one of the most important pieces of legislation for investors and developers to come along in decades. The U.S. Department of the Treasury designated some 8,700 census tracts as Qualified Opportunity Zones (QOZs). The law is designed to attract investment into economically disadvantaged areas in exchange for some advantageous, albeit complex, federal tax benefits. A number of funds have sprung up to take advantage of this new legislation, that contain assets ranging from single family homes to agriculture investments.
The most important items for investors in QOZ funds to be aware of include:
There is a temporary tax deferral on reinvestment of capital gains within 180 days from sale in a Qualified Opportunity Fund (QOF) until December 31, 2026. Unlike a 1031, which requires a “like kind exchange,” the rules for the types of gains that can be deferred are much more flexible. They can include gains from the sale of real estate, stocks, or businesses. The Proposed Regulations released on Oct 26, 2018 anticipate that investor will file a Form 8949 to make the deferral election.
Investors receive a step-up in basis by 10% of the original invested gain after a 5-year hold and 15% after a 7-year holding period. It is anticipated that most QOZ funds will be oriented towards longer term investors.
The investor will receive tax free appreciation on funds invested in a QOF fund after a ten years. So for example, if your original investment into the fund appreciates by $100,000, you will pay no capital gains on that appreciation after ten years, but you will still need to be prepared to recognize taxes on the original gain invested by December 31, 2026.
The current QOZ designations will expire on December 31,2028. However, proposed regulations permit taxpayers to elect a basis step-up after 10-year hold period under IRC Section 1400Z-2(c) after the QOZ designations expire. Moreover, the election for 10-year gain exclusion is extended until December 31, 2047.
If you think you want to syndicate a project in a QOZ, you should be aware of the following:
Investment Basis Rules
The original investment basis must increase by 100% in market value subject to certain rules. This means a stabilized cash-flowing project will likely not meet the criteria, but a development project that at least doubles the value of the initial equity put into the property probably will. Also, the recent proposed rules say that the basis of the land value is not taken into account to meet the “substantially improved” requirement.
At least 70% of a tangible property owned or leased by businesses must be a QOZ business property as defined by the IRS.
Any corporation or partnership for tax purposes can self-certify to become a QOF using Form 8996. The same form will be used for annual compliance reporting for the 90-Percent Asset Test (90% of a fund’s assets must be invested in a QOZ).
Single Project Possibility
Though investment funds commonly represent a pool of various investments, QOZ funds may invest in a only single project. This structure could be less complicated for someone investing in a single large project.
Opportunity Zones should be a great tool for investors and developers alike, and bring much-needed capital to disadvantaged rural and urban areas. That said, the rules for QOZ funds are quite complicated and still under development. Consult your tax professional before making any investment decisions.