As the end of the year approaches many individual and business taxpayers are searching for ways to reduce their overall taxes. This has proven challenging for many because the sweeping changes implemented by the Tax Cuts and Jobs Act of 2017 (tax reform), has significantly changed/removed many of the most common tax incentives. Despite the change, there are still opportunities to reduce taxes through programs such as participating in the Qualified Opportunity Zone program. The program is designed to help economically struggling zones by offering an incentive to taxpayers that make a qualifying investment. The framework for the program and how it functions has been available for several months, but many have been waiting for the initial IRS proposed regulations regarding how the program will be administered. On October 19th, the IRS issued the long-awaited guidance which provides essential insights for taxpayers considering participation. To help clients, prospects and others understand the guidance and how it impacts their situation, Hanson & Co. has provided a summary overview of key facts below.
Proposed Regulations – Qualifying Opportunity Funds
The proposed regulations provided a great deal of useful information about how the program will be administered including clarification on the ways an entity can be designated as a Qualified Opportunity Fund (QOF). It’s important to note that in order to leverage Opportunity Zone (OZ) credits, taxpayers must first form (or join) a QOF. These are entities organized as a corporation or partnership that invest at least 90% of its assets into QOZs. The 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 a qualifying property.
The 90% investment threshold is calculated as an average of two numbers:
The percentage of qualified assets on the last day of the first six month period of the entity’s taxable year; and,
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 which was 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 the 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.
Other Key Insights
There was also another important clarification made by the IRS, including:
The capital gain cannot be as a result of a transaction with a related person.
Almost all capital gains will qualify for the deferral and 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 if they reinvest those amounts into another QOF.
The 180-day period in which taxpayers must invest in a QOF typically 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.
Identifying ways to limit and reduce taxable income is an essential practice that makes sense for taxpayers to focus on. The various changes implemented by tax reform have changed the available opportunities for many to leverage. The tax incentives available through the Qualified Opportunity Zones Program represents a significant opportunity for those looking for additional tax savings boost. While there are still several questions and issues that need to be considered, the temporary regulations provide essential insights. If you have questions about the program or what the proposed regulations mean for your situation, Hanson & Co. can help. For additional information please call us at 303-388-1010 or click here to contact us. We look forward to speaking with you soon.