Private investors can participate in the program with the following guidelines:
• Investors must invest through newly created Opportunity Funds that purchase and improve real estate or businesses.
• Investors may reinvest capital gains from existing investments and can defer or reduce those taxes.
• After ten years, investors permanently avoid any capital gains tax on their reinvested funds.
• After the investment is held for five years, the tax basis for the original investment is increased by 10 percent and is increased by 15% after ten years, thereby reducing realized capital gains.
• The fund must comply with the requirement to “substantially improve” an OZ by investing in rental properties, hospitality, offices and industrial buildings, and other community equity opportunities.
• There is no maximum investment amount, but there is a minimum requirement of $50,000.
How to Receive a Tax Benefit under Code Section 1400Z.
The program allows investors to roll-over capital gains from an unrelated investment into a Qualified Opportunity Fund (“QOF”) within 180 days of disposition. The QOF must hold at least 90 percent of its assets in QZ properties.
The investor receives stock certificates or membership equity in the fund, and is allowed to reduce his or her tax basis after five years (10%), an additional five percent after seven years, and if they hold the investment for a total of 10 years, they are not taxed on any appreciation of their interest.
This incentive is a significant benefit for investors as it allows them to sell their investment after ten years and pay zero taxes on any gain realized from their participation.
What Defines an Opportunity Zone?
In order to establish Qualified Opportunity Zones, governors of each state were required to nominate and submit a list of identified communities to the Secretary of the Treasury by April 20, 2018. Areas can be designated as a QZ if they are low-income communities as defined in Section 45D(e) of the Code for New Markets Tax Credits.
Each state can nominate no more than 25% of its identified census tract low-income communities. States can also nominate census tracts contiguous with low-income communities if the median family income in those designated areas does not exceed 125 percent of the Qualified Opportunity Zone.
To date, there are 53 states and U.S. territories that have submitted Qualified Opportunity Zones. A current list of zones is available on thewebsite.
Qualified Opportunity Zone Properties
The fund must hold 90 percent of its assets in Qualified Opportunity Zone Property, which may include Qualified Opportunity Zone Stock, Qualified Opportunity Zone Partnership Interest, or Qualified Opportunity Zone Business Property.
Each OZ property must meet the following qualification criteria:
Qualified Opportunity Zone Stock – Any domestic corporation stock obtained by the fund after December 31, 2017, from a corporation identified as a Qualified Opportunity Zone Business when the stock was purchased. The corporation must qualify as a Qualified Opportunity Zone Business for a majority of time during the fund’s holding period.
Qualified Opportunity Zone Partnership Interest – Any capital or profits interest in a domestic partnership that is identified as a Qualified Opportunity Zone Business when the stock was purchased. It must remain as a Qualified Opportunity Business for a substantial duration of the fund’s holding period.
A Qualified Opportunity Zone Business means a business that owns or leases substantially all of its tangible property in a Qualified Opportunity Zone Business Property. The company must also generate at least 50 percent of its total gross income from active business conducted with “a substantial portion of the intangible property of such entity used in the active conduct of any such business,” and “less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity attributable to nonqualified financial property.”
Qualified Opportunity Zone Business Property – This is tangible property acquired after December 31, 2017, which is used in a Qualified Opportunity Zone trade or business where either the use of the property originates with the fund, or the fund substantially improves the property during a substantial period being in a Qualified Opportunity Zone.
Benefits to Real Estate Developers and Passive Investors
This program allows developers to start a fund to generate third-party investment capital for their building projects. They can then use the fund to defer tax on the sale of capital assets when applying that capital to the fund.
If a developer invests their capital gains from the sale of asset into a Qualified Opportunity Fund for eight years, they can increase their tax basis, and the possibility to end up paying only 57% of what they otherwise would have in taxes at the time of liquidation.
For a passive investor, the Qualified Opportunity Fund allows them to defer tax payments on recognized gains for up to eight years, with at least a 15% reduction and possible elimination of any tax on their gained interest if they hold the investment for at least ten years.
This new investment vehicle will provide significant tax advantages and opportunities for investors while generating needed revenue for development of low-income communities across the nation. It offers both short and long-term tax deferral, capital gains reductions, and may be a useful tool for investors, developers, managed funds, and companies considering investment in economically disadvantaged communities.