When tax reform, known as the Tax Cuts and Jobs Act, was signed into law in December of 2017, it ushered in significant changes to the tax code. For individuals, there were many including as an increase in the standard deduction, repeal of the personal exemption, changes in tax brackets and expansion of the child tax credit. There were also many benefits for businesses including a 14% reduction in the corporate tax rate, elimination of AMT, introduction of the Qualified Business Income (QBI) deduction and more.
A lesser known change was the introduction of Qualified Opportunity Zones (QOZ) which represent a powerful tax planning tool for those seeking a way to defer their capital gains tax liability. While there has been much published on the topic and how taxpayers can participate, there are still many questions about the program details. To help clients, prospects and others become more familiar with the program, Hanson & Co. has compiled a list of the common questions asked below.
What are QOZs?
QOZs are economically-distressed communities that were nominated for QOZ designation by their state and subsequently certified by the Secretary of the U.S. Treasury who keeps an updated list of approved QOZs here.
How long will QOZ designations remain in effect?
Distressed communities that were granted QOZ designation will remain QOZs until December 31, 2028.
How can one invest in a QOZ?
To receive the tax benefits, taxpayers must invest their realized capital gains into an opportunity zone fund within 180 days of the sale. Taxpayers cannot invest into a QOZ directly but rather must utilize a qualified opportunity fund.
What are Qualified Opportunity Funds (QOF)?
A QOF is an intermediary investment vehicle, structured as a partnership or a corporation. A QOF must hold at least 90% of its assets in Qualified Opportunity Zone property.
A fund can either be an existing entity, or a newly formed entity. The partnership or corporation “self-certifies” its status as a Qualified Opportunity Fund with Form 8996, which is filed annually with the entity’s tax return.
What is a Qualified Opportunity Zone Property?
Qualified Opportunity Zone Property can either be:
(1) Qualified Opportunity Zone Stock – Stock in a domestic corporation, received solely for cash at original issuance. The corporation must be a qualified opportunity zone business.
(2) Qualified Opportunity Zone Partnership Interest – A capital or profits interest in a domestic partnership, acquired solely in exchange for cash. The partnership must be a qualified opportunity zone business.
(3) Qualified Opportunity Zone Business – Trade or business in which substantially all of the property held by the taxpayer is located within a qualified opportunity zone.
In any case, the original use of the property within the QOZ must commence with the opportunity zone fund. In other words, an opportunity zone fund cannot purchase equipment already located and in use in a QOZ and expect for its investors to receive the tax deferral benefits of QOZ investment.
How quickly should opportunity zone funds invest their property into QOZs?
The proposed regulations have not explicitly stated how quickly funds should invest into QOZs once they receive capital. However, the 90% test must be satisfied on the last day of the first 6-month period of the fund’s taxable year, and on the last day of the fund’s taxable year.
Can opportunity zone funds invest in multiple opportunity zones?
Yes, as long as at least 90% of their assets are invested in QOZs.
What benefits will investors receive?
Investors will receive up to three tax benefits for investing in a QOZ:
1) A temporary deferral of capital gains that are reinvested into an opportunity zone fund;
2) A step-up in basis, of up to 15% of the original deferred capital gains, provided the investment is held for 7 years; and
3) A permanent exclusion from income on the appreciation of the QOF after initial investment, provided that the investment in the QOF is held for at least 10 years before disposition.
What happens when investors sell their QOZ investment?
The tax deferral provided by this incentive program will end once investors sell their QOZ investments. The only way they can continue to defer their gains is if they reinvest those proceeds into other opportunity zone funds.
When was this tax incentive passed, and when is it effective?
The QOZ incentive was written into law with the passage of the Tax Cuts and Jobs Act of 2017, and it became effective immediately. Unfortunately, the IRS has not yet finalized how it interprets the law. Late last year, the IRS released proposed regulations that clarified how the Federal government would implement the new law, but the final regulations are still forthcoming.
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It’s expected the IRS will issue final regulations in the near future. Although awaiting these regulations, it doesn’t mean taxpayers should not take advantage of the program. The QOZ incentive represents an opportunity for qualifying taxpayers to defer capital gains tax over the long term. If you have questions about QOZs, details on program participation and overall benefits, 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.