Recent guidance released by the IRS and U.S. Treasury Department on Opportunity Zones helps resolve many issues with the new program. Treasury has requested public feedback and is expected to release more guidance by the end of the year.
Opportunity Zones are a new program created by the 2017 tax reform law to spur investment in distressed communities by providing tax benefits to investors. Taxpayers selling appreciated assets may roll their capital gains into a Qualified Opportunity Fund that invests in a zone. Proponents of the program point out that there is a $6 trillion pool of appreciated assets that could be unlocked by these Opportunity Zones.
The program provides two benefits. First, the capital gains taxes that would normally be due on the initial assets invested into a fund are deferred until December 31, 2026. Second, investments in the fund that are held long-term get to permanently exclude a portion of any subsequent gain: 10% of the gain is excluded if held for longer than 5 years, 15% is excluded if held for more than 7 years, and 100% of the gain is excluded if held for more than 10 years.
Unlike the New Markets Tax Credit and Low-Income Housing Credits, the tax benefits from Opportunity Zones are uncapped. That is, there is no specific federal allotment of tax benefits that cannot be exceeded by the taxpayer. And unlike a Like-kind Exchange, which requires a rollover of 100% of the proceeds of the original investment to get the full benefit of tax deferral, taxpayers only invest their gains into an Opportunity Fund.
The Treasury department has posted an Opportunity Zone Resources page on its website, where you can find a map of the designated zones, along with a Frequently Asked Questions document.
Highlights of Proposed Regulations
- Since the Zones’ designations expire in 10 years, there was a question of whether funds created after 2018 could meet the 10-year investment period for the full step-up of basis. The proposed regulations clarify that they do qualify.
- Taxpayers eligible to defer gains include individuals, partnerships, RICs, REITs, C and S Corporations, trusts and estates.
- The investments in the zone must be “original use” in the hand of the fund, which is satisfied if, within 30 months of purchase, the fund spends at least as much in improving the property as it did to purchase the property. The new guidance clarifies that this is computed without regard to the cost of the land.
- Example: A property is purchased for $800, 40% of the value is attributable to the building ($320) and 60% to the land ($480). Therefore, at least $320 of improvements must be made within 30 months.
- The law requires that “substantially all” of a trade or business’ tangible property be qualified Opportunity Zone property. “Substantially all” was defined in the proposed regulations as 70% or more.
For more information, please contact ICSC’s Vice President of Tax Policy, Phillips Hinch.
Phillips Hinch
Vice President, Tax Policy