Update on the Qualified Opportunity Fund ProgramBy Michael W. Hurwitz | July 27, 2018
By now, most real estate professionals have heard about the Qualified Opportunity Fund program created by the Tax Cuts and Jobs Act of 2017 (TCJA). The program is designed to incentivize investment into low-income communities by affording substantial tax benefits.
In general, the Qualified Opportunity Fund program allows the gain from the sale or exchange of a capital asset to an unrelated party to be reinvested into a Qualified Opportunity Fund, thereby deferring or excluding taxation on that gain. To qualify, the fund must be invested in a property within a qualified opportunity zone, which are low-income census tracts specially designated by each state.
Taxpayers must reinvest the capital gain within 180 days of the sale or exchange of non-opportunity-zone assets (including stock, partnership interests, real estate and property used for personal purposes) before December 31, 2026, in order to take advantage of the provision’s beneficial tax treatment.
As addressed in my earlier article on this topic, the Qualified Opportunity Zone program offers three distinct tax benefits:
- A temporary tax deferral of capital gains that are redeployed into a Qualified Opportunity Fund. The gain will be deferred until the earlier of: the date on which the investment in the Qualified Opportunity Fund is sold, or December 31, 2026.
- A capital gain reduction through a basis adjustment for gains that are redeployed into a Qualified Opportunity Fund. A taxpayer who holds an interest in a Qualified Opportunity Fund for at least five years can increase his investment basis by 10% of the deferred gain (and an additional 5% if the investment is held for seven years), thereby eliminating potentially 15% of the original gain from taxation.
- A permanent gain exclusion on the appreciation of interest in the Qualified Opportunity Fund. If a taxpayer holds an interest in a Qualified Opportunity Fund for at least 10 years, no tax will be due on the appreciation of the Qualified Opportunity Fund. However, because the statute requires the deferred gain be recognized by December 31, 2026, the permanent exclusion is thereby limited to the above-mentioned 15% of the original gain.
All of these tax benefits are designed to reward long-term investments in distressed, low-income communities. However, the program could result in financial risk of your investment, so it’s important to consult with your tax advisor to understand all possible consequences.
While we are still waiting for additional guidance and clarification from the IRS, there is some additional information available since the program was introduced under the TCJA late last year. Here’s what we know now:
- Where are the qualified opportunity zones? When the TCJA was originally enacted, it tasked state governors with nominating qualified opportunity zones in their state by the spring. The zones needed to qualify as low-income communities as defined in Code Section 45D(e).
The zones then needed to be approved – or “certified” – by the Secretary of the Treasury. A full list of certified zones, as well as an interactive map, can be found here.
- Which types of funds qualify? To be considered a qualified opportunity fund, the fund must hold at least 90% of its assets in a qualified zone property.
Qualified opportunity funds will typically come in the form of a privately managed investment vehicle such as a corporation, partnership or limited liability company. The fund’s sole purpose is to invest directly into a certified qualified opportunity zone property.
- When and how do I get started? Now that the qualified opportunity zones have been announced, investors are already taking advantage of the tax benefits this program affords. Consult with your Marks Paneth tax advisor if you are considering utilizing this investment vehicle. Certain steps, such as self-certification and tax return elections, must be taken to realize the tax benefits of a qualified opportunity fund.
The benefits can also be realized retroactively through an amended 2017 return, if you invested in a qualified opportunity zone last year.
For more information on this new program, its benefits and potential pitfalls to avoid, contact your Marks Paneth tax advisor or me at firstname.lastname@example.org.
Jodi has an unrealized capital gain in the amount of $1 million on some stock in her investment portfolio. Because Jodi consulted with her CPA, she decided in early 2018 to sell her position and reinvest the gain into a Qualified Opportunity Fund that invests in distressed low-income communities in downtown Buffalo, NY. Jodi anticipates holding this investment for at least 10 years. Clearly, Jodi will be able to defer the capital gains tax on the $1 million stock investment until December 31, 2026. Furthermore, she will be able to increase the basis of the investment by 15% of the $1 million deferred gain, resulting in only
$850,000 being subject to taxation when the investment is ultimately disposed of. In addition, Jodi will owe no tax on the appreciation after the investment is made in the Qualified Opportunity Fund.
About Michael W. Hurwitz
Michael W. Hurwitz, CPA, MST, is a Partner and REIT Group Leader at Marks Paneth LLP. Mr. Hurwitz brings more than 30 years of experience and a versatile set of skills acquired through working for both public and private companies in the real estate sector. His industry knowledge spans a vast number of areas including real estate tax issues, public and private real estate investment trusts (REITs), opportunity funds, portfolio restructurings, acquisitions and dispositions, partnership... READ MORE +