The 2017 Tax Cuts and Jobs Act (TCJA) not only slashed individual and corporate tax rates, it also created valuable tax incentives for helping to revitalize local communities through a program that designates Qualified Opportunity Zones across the U.S.
Here are the details, including how you can take advantage at tax time.
Qualified Opportunity Zones
Created by the Tax Cuts and Jobs Act in 2017, Qualified Opportunity Zone, or QOZs are an economic development tool—designed to spur economic development and job creation in distressed communities.
In plain English, the government is willing to cut your taxes if you are willing to invest in areas that are in need of economic revitalization. Companies and individuals are encouraged to open businesses in these areas in exchange for tax incentives to help improve the economy and create jobs for the residents.
These tax benefits can be significant for you, including tax deferrals which give you the opportunity to delay tax payments until 2026 OR until the business closes or is sold.
And if you are willing to sustain the business in a community for 10 years, taxes owed on profits are forgiven!
QOZ plans are now in place for communities in all 50 states. Each state nominates blocks of low-income areas by census tract, which are then certified by the Secretary of the U.S. Treasury through his delegation of authority to the Internal Revenue Service.
You can find eligible properties any state in the U.S. by visiting the U.S. Treasury Department’s Community Development Fund site here.
- The website allows you to view an entire spreadsheet of QOZs across the country.
- Also, there is a mapping feature that allows you to zero on a specific state or community.
Qualified Opportunity Funds
A Qualified Opportunity Fund, or QOF, is a special purpose vehicle structured as either a partnership or corporation for the purpose of investing in an QOZ, whether the investment is in real estate or directly in one or more businesses. The fund is required to hold at least 90% of its assets in that qualifying QOZ area.
The QOZ program is designed to spur economic development by providing tax incentives for people who are willing to invest new capital in businesses in that community. These include …
- First, an investor can defer tax on any prior eligible gain to the extent that a corresponding amount is timely invested in a Qualified Opportunity Fund (QOF).
- The deferral lasts until the earlier of the date on which the investment in the QOF (fund) is sold or exchanged, or December 31, 2026.
- If the fund investment is held for at least 5 years, there is a 10% exclusion of the deferred gain.
- Additionally, the amount of eligible gain to include is decreased to the extent that the amount of eligible gain you deferred exceeds the fair market value of the investment in the fund.
- Second, if the investor holds the investment in the fund for at least 10 years, the investor is eligible for an adjustment in the basis of the fund investment to its fair market value on the date that the fund investment is sold or exchanged.
- As a result of this basis adjustment, ALL the appreciation in the QOF investment is never taxed. A similar rule applies to exclude the QOF investor’s share of gain and loss from sales of QOF assets.
Several key requirements must be met to receive tax deferral:
- First, it only applies to the portion of your investment that was a qualifying investment in a QOF partnership or QOF S corporation, and that you held for at least 10 years.
- Second, the election to exclude gains and losses may be made for each year during which there are asset sales by the fund or certain partnership interests.
- Third, the gain from that sale was not derived from the sale of inventory in the ordinary course of a trade or business, and
- Fourth, the QOF must distribute the net proceeds from the sales within certain time periods.
You can take advantage of these tax incentives even if you don’t live, work, or have an existing business in a QOZ. All you need to do is invest the amount of a recognized eligible gain in a QOF and then you may elect to defer the tax on that gain.
Investing in Qualified Opportunity Zone Property
The program applies to any qualifying ownership interest in a corporation or partnership that operates a business in a designated QOZ, OR certain tangible property owned by the fund that is used in a business in the QOZ.
Tangible property is considered QOZ business property by the IRS if …
- It is used in a trade or business of the QOF or in a QOZ business,
- It was purchased after December 31, 2017,
- The original use of the property in the QOZ commenced with the QOF or QOZ business OR the property was substantially improved by the QOF or QOZ business; and
- During substantially all of the time the QOF or QOZ business held the property, substantially all of the use of the property was in a QOZ.
Your opportunity funds must make “substantial improvements” to the properties in which they invest. The IRS defines substantial improvements as investments in the property that are equal to the original value paid by the fund. These improvements must be made within 30 months.
Details about How to Defer Your Eligible Gains
You can also take capital gains from other property and make it tax deferred under the QOZ program.
Gains that may be tax deferred include both capital gains and qualified 1231 gains, but only gains that would be recognized for federal income tax purposes before January 1, 2027, and that are not from a transaction with a related person.
For you to get the tax deferral, the amount of the eligible gain must be reinvested in a QOF in exchange for an equity interest in the QOF.
Also, you can transfer property other than cash to a QOF, such as other property or assets you own. The amount of gain that can be tax deferred is limited to the cost basis of the contributed property, even if a greater value of property is transferred.
Finally, if you have investments in either a Regulated Investment Company (RIC) or a Real Estate Investment Trust (REIT) you can also defer capital gain dividends on these assets by reinvesting in a QOF.
Summary: The IRS allows you to defer paying tax on capital gains from the sale of property in qualified opportunity zones as long as the gains are invested in a qualified opportunity fund. The fund must invest 90% of its assets in businesses or property used in one of these designated low-income communities.
Depending on the holding period, eligible capital gains from investments in a qualified opportunity fund can avoid tax on up to 15% of the original gain and defer tax on the remaining original gain until the sale of the fund or the end of 2026.
Many tax questions come into play when considering the benefits of investing in opportunity zones. At TSP Family Office, we can walk you through the process of evaluating this potentially lucrative tax savings benefit. Just give us a call and happy to share all the details with you personally.