The 2018 Tax Cuts and Jobs Act (TCJA) brought about the most significant revisions to the U.S. tax code in over 30 years. Since the passage of the new tax bill, which went into effect on January 1, 2018, the focus of most taxpayers has centered on the reduction in the corporate tax rates and the introduction of the qualified business income (QBI) deduction, available for owners of certain pass-through entities. While these provisions captured most of the headlines, many taxpayers may have overlooked another TCJA provision that could potentially yield thousands of dollars in tax savings and deferrals.
Qualified Opportunity Zones
Through Code Sec. 1400Z-2 of the TCJA, the government incentivizes business investment in certain communities across the country identified as qualified opportunities zones (QOZs). Such QOZs are designated by state governors, subject to certain parameters established by the Treasury Department. A listing of the qualified opportunity zones throughout the country may be found here.
Investments in QOZs provide opportunities for both deferral and nonrecognition of capital gains tax as follows:
- Tax Deferral – Capital gains proceeds that are reinvested into a qualified opportunity fund (QOF) within 180 days of the related capital asset(s) sale may qualify for temporary deferral of taxable gain. The deferral period is limited to the QOF investment disposition date of December 31, 2026. (See the How to Invest in Qualified Opportunity Zones section below for an explanation of qualified opportunity funds.)
- Basis Adjustment – QOF investors can reduce the amount of realized capital gain subject to taxation from the eventual sale of QOF assets, depending on the length of the holding period. QOF investment held for up to five or seven years qualifies for a step-up in basis equal to 10% or 15%, respectively, of investment amount attributable to prior deferred capital gain mentioned above. QOF investments held for a minimum of 10 years may qualify for a step-up in basis equal to fair market value, resulting in permanent capital gain exclusion.
How to Invest in Qualified Opportunity Zones
Taxpayers must create a QOF in order to invest in QOZs. A QOF, as defined by the Treasury Department, is a partnership or corporation established for the purpose of investing in QOZ property; at least 90% of the QOF’s total assets must be identifiable as QOZ property. QOZ property is classified into three categories:
- QOZ Stock – Stock in a domestic corporation engaged in QOZ business. Such stock must have been purchased via cash-only consideration subsequent to December 31, 2017.
- QOZ Partnership Interest – Similar to QOZ stock, QOZ partnership interest must relate to a domestic partnership engaged in QOZ activity. Acquisition of partnership interest must have occurred subsequent to December 31, 2017 via cash-only consideration.
- QOZ Tangible Business Property – Tangible property must be used under the capacity of a QOF trade or business. In general, original use of the property may not preclude the incorporation/organization date of the QOF. However, an exception applies for taxpayers who make “substantial improvements” to qualified property placed in service prior to establishing a QOF.
If you are considering incorporating Qualified Opportunity Funds into your construction and/or real estate business, please contact one of our tax advisors at 301.231.6200.