The Tax Cuts and Jobs Act of 2017 brought with it many changes to our country’s tax code. One of the changes that seeks to bring a positive impact to communities across the country is known as Qualified Opportunity Zones. Under this new legislation, chief executives of each state, typically the governor, can nominate certain communities in the state to be designated as low income communities. If approved by the U.S. Secretary of the Treasury, the communities can keep this designation for 10 years. Investments in these areas are made through qualified opportunity funds which are set up as either partnerships or corporations. These funds must invest at least 90% of the assets in qualified zone property.
The purpose of this new addition to the tax code is to incentivize private investment in low income communities and spur economic development in these areas through preferential tax treatment to investors. There are three benefits that investors can receive through qualified opportunity funds.
- The first is a deferral of capital gains. Investors have 180 days from the date of sale of other investments to roll over capital gains into qualified opportunity funds. This roll over will allow the investor to defer recognition on the original gain until either the sale of the investment or December 31, 2026, whichever is earlier.
- Depending on when the investment with the rolled over capital gain is made, investors can also receive a step up in basis on the deferred capital gain. If the investment is held in the fund for 5 years, investors will receive a 10% step up in basis. The investment must be made by 2021 to reach the 5-year mark by 2026. Investors will receive an additional 5% step up in basis if their investment is held in the fund for at least 7 years. The investment must be made by 2019 to be eligible to receive a total 15% step up in basis.
- The most attractive incentive for investors is if an investment is held for at least 10 years, giving the investor a step up in basis equal to the fair market value of the investment on the date of sale. This permanently excludes any capital gains tax that would have been recognized from the sale of the qualified opportunity fund investment.
The creation of Qualified Opportunity Zones by the federal government is an ambitious effort to boost private investment in low income communities. Further guidance can be expected from the IRS, pertaining to both investors and the qualified opportunity funds that are formed to invest in these communities.
