New York State Decouples from Federal Opportunity Zone Tax ProvisionsApril 20, 2021
The recently announced New York State fiscal year 2022 budget includes legislation which “decouples” New York from the federal income tax deferral available for investments in Opportunity Zones, beginning generally as of January 1, 2021.
From a federal standpoint, there have been three major benefits to taxpayers who invest in Opportunity Zones:
Deferral of tax on original capital gain: A taxpayer can defer paying tax on an eligible gain that is reinvested in an Opportunity Zone within the requisite time frame (generally 180 days).
Reduction of tax on original capital gain: A taxpayer holding its Opportunity Zone investment for at least five years prior to December 31, 2026, will receive 10% forgiveness when this gain is recognized on said date. A taxpayer who makes a qualifying investment by December 31, 2021, will only recognize 90% of this original gain if they still hold the investment on December 31, 2026.
Permanent exclusion of Opportunity Zone investment gain: If a taxpayer holds its Opportunity Zone investment for a least 10 years, the entire appreciation in this investment escapes federal taxation when it is sold – known as the “10 year benefit.”
The decoupling in the New York State budget now provides that any original eligible gain deferred for federal purposes will be added back in when determining a taxpayer’s taxable income for New York purposes. When that gain is subject to federal income tax in 2026 or earlier, it will be excluded from the New York taxable income, so New York will only tax the gain once—but see below.
This provision is effective for taxable years beginning on or after January 1, 2021. However, any 2020 capital gains that are still eligible for deferral for federal purposes remain eligible for deferral in New York, so long as the requisite 180-day reinvestment period is met. The 180-day period begins on the date of sale if the capital gain is realized directly by a taxpayer. If it is a K-1 gain, taxpayers can choose from one of three start dates for the 180-day period: (1) the date the flow-through entity realized the gain; (2) December 31, 2020; or (3) the due date of the flow-through entity’s tax return without extensions (March 15, 2021 for partnerships).
Depending on the date of sale and the manner in which a capital gain is recognized, there is still time for New Yorkers to reinvest 2020 gains in 2021 and receive both the federal and New York tax benefits. However, a New Yorker with a 2021 gain loses the tax benefits for New York purposes.
As of now, and based on the exact wording of the legislation, New York has not decoupled from the 10 year benefit. Accordingly, gain from the sale of an Opportunity Zone investment may still be eligible for exclusion from income for both federal and New York purposes, assuming the requisite 10-year holding period is met. The question remains as to whether this is a drafting error which New York will eventually correct.
A few additional observations:
As Marks Paneth’s Real Estate Group has previously noted, a deal should make economic sense apart from the Opportunity Zone benefits. Tax benefits can make a good deal great, but they can’t make a bad deal good. While the New York State budget legislation reduces the overall tax benefit of Opportunity Zone investments, don’t lose sight of the fact that the federal benefits remain intact. At present, the Biden administration has talked about increasing transparency regarding Opportunity Zone investments but not eliminating them.
The aforementioned addback and exclusion mechanism for determining New York taxable income avoids double taxation for state purposes if the taxpayer is subject to New York tax in both the year of the original gain and the year it is included (even at a reduced amount) in federal taxable income. However, this does not prevent double taxation at the state level in all cases. For example, a New York taxpayer who becomes a resident of another state by the time the original deferred gain is recognized for federal purposes, and which has not decoupled, will not benefit from the New York exclusion of said gain, since he or she won’t be a New York resident at that time.
Marks Paneth will continue to monitor developments and will provide updates as they become available. Contact Alan M. Blecher, Tax Principal in our Real Estate Group, or your Marks Paneth advisor for more information and visit our Opportunity Zones Resource Center.