What are Qualified Opportunity Zones?
Qualified Opportunity Zones were created with the Tax Cuts and Jobs Act of 2017. This new law encourages long-term investment in low income communities by providing significant federal tax benefits for investors that invest in these designated "Opportunity Funds."
Who qualifies for this incentive?
Any corporation, partnership, or individual that is subject to U.S. federal income taxes qualifies for the tax incentives if they invest in a Qualified Opportunity Fund within 180 days of the new law being enacted, 12/22/2017.
When are funds needed to be invested by?
The new law requires investments into specific qualified opportunity funds to take place prior to 12/31/2026.
How are the funds taxed in the future?
If investments are held for at least 10 years, future income earned from the investment will not be subject to corporate taxes. If investments are held for at least 7 years, further deferrals may be achieved by investing in low-income communities. These investments must be held for at least 10 years to take advantage of the maximum deferral.
What is the capital gains rate?
The long-term capital gains tax rate is capped at 15%–20% based on income, which can be deferred to future years if the investment is held long enough. This increased cap will save taxpayers approximately $644 billion over the next 10 years.
What types of Qualified Opportunity Funds are available?
There are both public and private opportunity funds that have been created in order to take advantage of the increased capital gains rates for qualified investments, subject to certain requirements. The two main types are state-sponsored funds, which can be governmental entities or non-profit corporations; and private sector funds, which can be sponsored by financial institutions or corporate entities.
What is the definition of a low income community?
A qualified opportunity zone must be designated by (1) the governor of each state in which one or more census tracts with average poverty rate of at least 20% are located; (2) the mayor of the District of Columbia or (3) any governmental entity in certain rural areas.
Are there specific types of investments that are encouraged by this new law?
Yes. The tax incentives encourage long-term investments into areas that have experienced significant poverty for at least 5 years relative to other parts of the state, D.C. or U.S., and to property improvements in these areas, including:
- Construction or renovation of real property
- Infrastructure development (water, sewer, internet, rail)
- Business startup funding for entrepreneurs with a low income tax rate (maximum 15%) on capital gains
Are investments required? No, but the opportunity is not to be missed.
There is no formal requirement for a fund to invest in opportunity zones, but the federal tax benefits only apply if they do.
What are the benefits of investing in a qualified opportunity zone?
The new capital gains deferral is a one-time option that will not be available again unless Congress changes this law. The U.S. Treasury estimates that the incentive will cost approximately $1.2 billion during 2018 and will result in a loss of revenue of nearly $16.9 billion over 10 years, which is less than 0.1% of federal tax revenues in 2018 and a reduction of only about 1% for the next 10 years.
What are the income requirements to take advantage of these federal tax benefits?
Income requirements for the deferral/exclusion will be based on the income of the individual, trust or estate. Single individuals with income below $200,000 and married couples filing jointly with an income below $300,000 would qualify for a 0% long-term capital gains rate. The rate would be 15% for those with income between $200,000 and $500,000. For those above that threshold, the rate is 20%. The rates are up from the current top long-term capital gains rate of 20%, but still well below the 39.6% currently paid by high earners on ordinary income.
What types of investments may be available?
The law provides the Treasury Secretary with broad authority to designate investments that qualify, such as: active business income, capital gains from real estate and other qualifying assets.
Who is responsible for determining if an investment qualifies for these incentives?
A fund manager or sponsor is required to submit a certification to the Internal Revenue Service that a fund qualifies for these incentives. It is recommended that fee-only advisors review proposed investments to determine if they qualify before relying on a particular investment vehicle or technique.
What types of properties are available?
The law provides authority for Treasury Secretary to include any property deemed appropriate, subject to certain restrictions.
What are the timeline requirements for investments?
Investments must be made within 180 days of enactment or before December 31, 2026, whichever is earlier. Investments are deemed to have been made on the last day of the taxable year in which they were made. Qualified opportunity zone property acquired through a like-kind exchange that occurs after December 31, 2017, and before January 1, 2027 will be treated as qualified opportunity zone property if such exchange occurs within 180 days after the acquisition of the property. Assets acquired by a corporation (other than an S corporation) that is not a qualified opportunity zone business in a transaction to which section 1031(a) applies will qualify as a qualified opportunity zone asset if such assets are transferred to a qualified opportunity fund not later than the day after the date of their acquisition by the corporation.
What types of businesses may qualify?
In general, the law is meant to encourage investment in high-poverty communities that have been victims of recent natural disasters or areas designated by the state as "targeted investment communities," which will be designated by the Treasury Department.
How do the allocations work?
The law provides for a new type of corporation, referred to as a qualified opportunity zone business corporation (QOZBC), which is similar in many ways to an S corporation; however, there are no limits on the number of shareholders. QOZBCs provide for tax-free treatment to their shareholders with respect to income and gain, if they are invested in qualified opportunity zones by December 31, 2026. The law provides that at the election of a taxpayer, taxable income does not include 50% of any net capital gain from the sale or exchange of QOZBC stock held for more than five years.