A provision in the new Tax Cuts and Jobs Act allows for potential tax deferral and tax abatement on qualified property in qualified opportunity zones.
The new provision allows taxpayers to defer the capital gains tax due upon a sale of property if all or part of the capital gain portion of the sale is reinvested within 180 days in a “qualified opportunity fund.” Since only the capital gain amount must be reinvested, this could be a more attractive option than a like-kind exchange where all of the proceeds from the sale have to be reinvested. Any gain that the taxpayer does not invest must be recognized in the current year.
If the investment is maintained in the “qualified opportunity fund” for five years, the taxpayer will receive a step-up in tax basis equal to 10 percent of the original gain. If the investment is maintained in the “qualified opportunity fund” for seven years, the taxpayer will receive an additional five percent step-up in tax basis.
A recognition event will occur on Dec. 31, 2026, in the amount of the lesser of (i) the remaining deferred gain (accounting for earned basis step-ups) or (ii) the fair market value of the investment in the “qualified opportunity fund.” So theoretically, the capital gain could be deferred for up to nine years and partially reduced.
In addition to the tax deferral, if the investments are maintained for 10 years, an exclusion of all capital gains from post-acquisition gain on the investment in a “qualified opportunity fund” can be excluded from gross income. After 10 years, upon a sale of the investment, the new provision allows the taxpayer to elect the basis in the investment to be equal to the fair market value of the investment. This allows the taxpayer to exclude all of the capital gain from the investment in the qualified opportunity fund.
Qualified Opportunity Zones
These zones will be designated through a nomination of census tracts qualifying as “low-income communities” (as such term is defined under Section 45D of the Code for New Markets Tax Credits) by the governor of each state to the Treasury Department and certification of the zone by the Treasury Department. Each state may nominate up to 25 percent of designated low-income communities as “qualified opportunity zones.”
States may also nominate census tracts contiguous with “low-income communities” if the median family income in the designated census tract does not exceed 125 percent of the qualifying contiguous “low-income community.” The states must designate qualified opportunity zones from the pool, which are then subject to certification by the Treasury Secretary. The Treasury Department has 30 days to complete the certification.
Qualified Opportunity Funds
These funds will be determined by the Community Development Institutions Fund of the Treasury Department in a process similar to allocation of New Markets Tax Credits to “community development entities.” The “qualified opportunity funds” must maintain at least 90 percent of assets in “qualified opportunity zone property,” including investments in “qualified opportunity zone stock,” “qualified opportunity zone partnership interest” and “qualified opportunity zone business property.” The qualifications as “qualified opportunity zone stock,” “qualified opportunity zone partnership interest” and “qualified opportunity zone business property” encompass investments in new or substantially improved tangible property, including commercial buildings, equipment and multi-family complexes with a common requirement that such investments must be made in qualified opportunity zones. Taxpayers may invest in an investment vehicle that is certified as a qualified opportunity fund or a direct investment in property that has been certified as a qualified opportunity fund.
To learn more about the available designated opportunity zones, please click here.
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