The TCJA introduced the brand-new concept of Opportunity Zones and Opportunity Funds to encourage the creation of new businesses and the expansion of existing businesses in low-income communities.
- The concept starts with a taxpayer who has a taxable gain from the sale or exchange of an asset, including stock, partnership interests, real estate, and property used for personal purposes. (It is unclear whether gain from Section 1231 assets will also be eligible for reinvestment. The Code does not limit this benefit to capital gains; the Senate Committee Report does, and the dual character of Section 1231 assets adds to the confusion.) The taxpayer takes that gain amount (presumably, it is not necessary to invest the net sales price, as is the case with the reinvestment required under the like-kind exchange rules) and invests it in a certified Opportunity Fund within 180 days of the date the gain was realized. The Opportunity Fund can be taxed as either a corporation or a partnership for federal income tax purposes.
- That fund takes the amounts it receives from its investors and invests at least 90% of it into Opportunity Zone property. Opportunity Zone property can be stock in a corporation, an interest in a partnership or an LLC, or a direct investment into business property. The corporation, partnership, or business property must be located in a certified Opportunity Zone and not be involved in certain “sin” businesses — golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetracks or other gambling facilities, or stores with the principal business of alcoholic beverage sales for off-premise consumption.
- If all requirements are met (the rules discussed in this Update are not all-inclusive), the taxpayer will then be able to temporarily defer their original taxable gain tax until the earlier of the date on which the investment in the Opportunity Fund is sold or December 31, 2026. If the taxpayer holds their investment in the fund for five or seven years, they can receive a 10% or 15% reduction, respectively, of their original deferred capital gain tax. In addition, if the taxpayer holds on to their investment in the Opportunity Fund for at least 10 years, the taxpayer can completely avoid the taxation of any realized gain they recognize on the eventual sale of that fund investment.
The IRS had previously issued guidance on the process for Opportunity Zones to become certified and, to date, 15 states and 3 U.S. territories had their Opportunity Zones certified on April 9. (These were states that submitted their zone designations by March 22, 2018. However, a 30-day extension was available to the remaining states, so additional zones should be announced soon.) However, there was not much that taxpayers could do with that information until guidance on Opportunity Funds was also issued.
On April 25, 2018, the IRS released guidance on the process for Opportunity Funds to become certified. It appears, surprisingly, that the certification process will be quite simple. According to the IRS’s news release, “Opportunity Zones Frequently Asked Questions”, an entity that wishes to be treated as an Opportunity Fund will be able to self-certify by completing a form that will be released in the summer of 2018. That form will then be attached to the timely filed (including extensions) federal income tax return filed by the fund.
This is a much faster and less expensive certification process than the Treasury’s Community Development Financial Institutions Fund’s certification process for community development entities in the New Markets Tax Credit program and is therefore enthusiastically welcomed by both investors interested in the tax savings offered by reinvesting their taxable gains in Opportunity Funds and the businesses looking to locate in Opportunity Zones and be the recipients of such investments.
For a map of all designated Qualified Opportunity Zones (QOZ), click here.