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Qualified Opportunity Funds

By Michael W. Hurwitz  |  March 16, 2018

Qualified Opportunity Funds

This article was co-authored by Michael Hurwitz of Marks Paneth LLP and Nathaniel Razza of Goulston & Storrs. 

As part of the extensive Tax Cuts and Jobs Act of 2017 (TCJA), Congress created a little known but beneficial tax program to incentivize the inflow of capital investments into “qualified low-income communities”[1] or Qualified Opportunity Zones designated by the governors of each state[2]. The investment is made through a Qualified Opportunity Fund which is generally a privately managed investment vehicle organized as a corporation, partnership or limited liability company for the sole purpose of investing directly into a certified qualified opportunity zone property.

Similarly to deferred or like-kind exchanges, only taxpayers who roll over capital gains within 180 days of the sale or exchange of non-zone assets (including stock, partnership interests, real estate and property used for personal purposes) before December 31, 2026, will be able to take advantage of the beneficial tax treatment this provision provides. In general, the provisions allow for capital gain from the sale of any property to an unrelated party to be reinvested into a Qualified Opportunity Fund.

The Qualified Opportunity Zone program offers three distinct tax benefits, all of which are designed to reward long-term investments in distressed, low-income communities:

  1. 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.
  2. 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.  
  3. 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, other than the original deferred gain that must be recognized by December 31, 2026. 

Example:

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.

It is anticipated that taxpayers will be able to begin benefitting from this provision as soon as the Qualified Opportunity Zones have been certified by the Treasury. The initial deadline for states to identify the areas to be designated as Qualified Opportunity Zones is March 21, 2018; however, a 30-day extension is available. The Treasury will generally certify the states’ submissions within 30 days of receipt.

As with many of the new provisions in the TCJA, there are several issues the Internal Revenue Service will need to provide further guidance and clarity on, including:

  • Whether or not IRC Section 1231 property is intended to be covered by this program
  • Whether or not the taxpayer reinvests the sales proceeds or just the capital gain  
  • Whether or not a formal election is required to be made
  • Guidance on the 10-year hold as it relates to investments in 2019 and later years

Marks Paneth will be monitoring guidance released by the Internal Revenue Service as it pertains to Qualified Opportunity Funds and will provide updates as information is released.

If you have any questions, please contact:

Michael Hurwitz, Partner, Marks Paneth LLP

Nathaniel Razza, Director of Tax Accounting, Goulston & Storrs
(Mr. Razza is an accountant, not an attorney.)

_________________________________________________

[1] IRC Section 45D(d).

[2] As well as in the District of Columbia, U.S. possession’s and Puerto Rico.


About Michael W. Hurwitz

Michael W. Hurwitz Linkedin Icon

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 +


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